In today's episode, Warren Ingram delves into asset allocation, navigating the complexities of balancing stocks, bonds, cash, property, and shares to tailor your investment strategy. He'll guide you in aligning your portfolio with your financial goals and risk tolerance, emphasizing personalized approaches over generic solutions.
Questions/Topics:
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Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
In today's episode, Warren Ingram delves into asset allocation, navigating the complexities of balancing stocks, bonds, cash, property, and shares to tailor your investment strategy. He'll guide you in aligning your portfolio with your financial goals and risk tolerance, emphasizing personalized approaches over generic solutions.
Questions/Topics:
For more valuable insights from the 10x team, click here.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
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Speaker 2:Welcome to another episode of Honest Money. We're doing an episode in a similar structure to what we've done before, where we re-batch a whole bunch of your questions that you've been sending us and I try and cover a bunch of questions with one answer, because a lot of you cover kind of a similar range of topics in your questions and just to thank you so much for sending them through. We really appreciate it. It helps us a lot to know what we want to address with you and how we can give you content that's meaningful. So today I think we should be talking about how we address the mix of assets in your investments and how those get rebalanced and how often they get rebalanced. So the jargon for this is your asset allocation, and so just explain that first, and then how do you make some decisions around that? So let's kick off with the meaning of asset allocation. So asset allocation is about the combination of cash, bonds, property shares and any other investments that you've got in your investment portfolio, and often those could be in the form of individual investment. So you might have a bunch of exchange traded funds or you might have some gold coins and a property that you own and some shares, but it's the mix of how you put all that together and how different they are from each other that determines your asset allocation In the financial product world. So, for example, in unit trusts or in exchange traded funds, you'll find, for example, that you can get a balanced fund. So a balanced fund would have a combination of cash, bonds, property shares, both in South Africa and globally, and it would be packaged all into one product, one fund, and inside that fund you can on the fund information they've got horrible names, it's called a fund fact sheet and you've got to say that very carefully on a recording. But in that fact sheet you can see what the mix of assets are, what your asset allocation is. Importantly as well, you can see what the benchmarks are and what the fund manager or index tracker is allowed to do with your investments. So it might say, for example, that in this balanced fund they're allowed to go from 40% in shares up to a maximum of 75 and they might be allowed to have a minimum of 5% in cash and a maximum of 15 or whatever the deal is. But you should be able to see most of that in the fund fact sheet. If it's exchange traded fund, they're often the same sort of fact sheets available that you can make a call so you could buy one packaged product and achieve a particular asset allocation. And then what you do is you almost outsource the ongoing management of that asset allocation to the product provider.
Speaker 2:As long as you're comfortable with the range of shares inside that fund, you can say well, I've done what I need to do and I'm going to monitor the fund, but I'm not going to spend time and effort on the asset allocation. And that might work for some people. But for other people they would want a bit more control and maybe they don't want such a big range of cash, bonds, property and shares in their portfolio. They want a narrower range. So for you you might say well, actually, what I'm going to do is I'm going to buy an exchange traded fund or a unit trust that's a hundred percent in shares and that's going to make up on the beginning of the year. That's going to make up seventy five percent of my investments. Then I'm going to buy one that invests in cash it's going to be a money market, no, that's going to make up X percent. And then you buy a property one and that makes up Y percent. And when you put them together with bond Exchange traded fund or unit trust, then you've got your asset allocation done. But you've you've got the mix and the proportion right. So it's really up to you as to how you want that asset allocation to be created.
Speaker 2:I think it's quite a lot of work to kind of create them, your own asset mix, in a range of products, but for some people that's exactly what gives them a sense of comfort and control and as long as they're strategic about it and they have a long term focus, there's absolutely nothing wrong with it. What is important is that you need to make a clear and rational call on what your asset mix should be and as a starting point, I think there are a couple of nice factors you can use to make that decision. So the biggest one is how long you plan to invest the money. So if you are it's a thirty five years old and you plan to retire at sixty five, that means you've got a thirty year time horizon of accumulating money. And if you're sixty five and you retire completely, then you probably have another thirty, maybe thirty five years of of life. So your time horizon for your money for a thirty five year old, could be another sixty, five years.
Speaker 2:If that's the case, it means you should have a very high allocation to shares in your investment portfolio. Your asset allocation should be heavily biased to growth assets, and the best growth assets for most investors will be the stock market. And if that's the case, you know, then you might say well, I'm going to do that on my own. I'm actually just gonna buy a pure global exchange traded fund that invests in the world stock market With a chunk of my money and then I'm gonna buy a South African exchange traded fund that invests in the JSE and those two will make up, you know, let's say, a hundred percent of my investments, because my other asset is my house and I'm busy paying off that bond and that's my asset mix for now. If that's what works for you, you know, go for it by all means. But you should have a your time horizon for your investments. Should it should be biased in two shares. If you've got a long time horizon and if you've got, you know, a very short time horizon let's say you know you're saving to buy a new car, we're a placement car then maybe you've got three years of saving to do then I think you should have no shares and probably a hundred percent in cash or an income fund, income unit trust. So time horizon is a really critical factor when deciding your asset mix.
Speaker 2:The second big factor will be your, your actual financial position. In other words, do you have enough financial resources to look after yourself in the event that you have an emergency financial emergency or you lose your job? You know, so you know. You might say, well, I'm only thirty five, so my time horizon is, you know, sixty five years, but but I have no spare money, I have no other cash and I've only got that. Well then, I'm afraid you should have no shares right now. What you should do is pay off your debt and then start accumulating cash into an emergency fund and maybe, once you've got three months or six months in an emergency fund, then start building up your allocation to shares. So that would be completely different to someone who is sixty five years old and you know, and is about to retire and has a very good financial position where they're never going to run out of money. They could, although they're, the time horizon is shorter because their financial position is very strong. They could actually afford to take more risk because if their portfolio goes down, it's not going to compromise their position from daily living. You know their ability to look after themselves in the short term. So we in the industry that's called risk capacity. So now you've got time horizon and risk capacity.
Speaker 2:Then the third factor is psychological and it's the hardest one to judge and the most difficult one to manage, and that is your psychological tolerance for risk, because that's unique to each of us and it's totally independent of your financial literacy. Whether you've got a degree or a master's in investments, or whether you're a psychologist or anything, it doesn't matter what your level of education or experience is. Your psychological tolerance for risk is hardwired into you as almost I guess not quite from birth, but pretty close to then. So I view your tolerance for risk in the same way that you look at someone who's got a fear of heights or a fear of spiders. There is no logic or reason or rationality or education that can assist with either of those two things. It's something that's hardwired into that person. And so the psychological tolerance for risk is exactly the same and again, the jargon for that is your risk tolerance.
Speaker 2:So if you can tolerate big stock market moves where your portfolio is 100% in shares and the stock market loses half of its value. So you had a million rand and suddenly you've only got 500,000 rand. And if that doesn't cause you any panic or any reason or any motivation to suddenly chop and change everything and go to cash and kind of go to bed for the next year in depression, then you've got a high tolerance for risk. Whereas someone might be in a great financial position they might have an 80 year time horizon because they're only 20 years old but they're going to freak out, the moment they lose 5% of the investments. Their million rand suddenly gets to 950,000 just because the market's down and they go into a panic station. They've got very little tolerance for risk and that is a huge factor in deciding how much of your money you put into risky assets, which are unfortunately also the ones that give you the best capital growth and for most of us, as I said, that that's really going to be the stock market. So if you've got a low tolerance for risk, it is a huge factor in deciding how much of your money allocates to shares, unfortunately, because it's your investments and you pull the trigger on what you do.
Speaker 2:If you've got a low tolerance and someone like me sitting with you and I convince you to take a high exposure to shares because you're young and you're a lotto winner and you've got all the time in the world and all the money. That's not going to help at all. The first time we see a big stock market drop, it is going to cause you to panic and most likely your next action after you've started to panic will be an instruction to sell everything and move it to cash, and that causes permanent capital distraction. That's a loss of capital. So you've got to be very aware of your tolerance for risk when you start investing, and it's the combination of the three factors that determines what your mix of assets should be. And then, critically, you should at least once a year.
Speaker 2:I don't think you should do it more regularly, but if you decide every March of every year you're going to look at your asset allocation and just make sure that it's still correct, then that's a very good call. That's the right thing to do. I wouldn't do it every month, because investment markets move so quickly that in a month, let's say, your allocation to shares should be 75%. It could be that it's down at 70% or up at 80% in two or three months from when you did the last asset allocation, and that volatility is normal. That's part and parcel of being an investor, so you shouldn't be changing your asset mix or keeping it in a very narrow range too often.
Speaker 2:I think once a year you do a big rebalance to say, well, over the last year the stock market halved and interest rates trebled, so my cash portion of my investments is now 20% and the stock market is now only 50%. Then you might say, well, okay, now I'm going to reduce my cash and increase my allocation to the stock market. And if you do it in a very disciplined way and you do it once a year, it actually forces you to start buying things which are maybe a little bit cheaper and selling the things which are a bit more expensive. So just to use my example of the stock market again, if the stock market halves by the time your March rebalancing exercise comes around, it means that you're buying the stock market because it's halved, it's very cheap. It's forcing you to buy the stock market and allocate more money to the market at a time when the prices are low, and that's very good, very rational investment behavior.
Speaker 2:It's not human nature. Human nature is we hate to sell when things are down and we really hate to buy when markets have fallen by half, because that makes us nervous and human nature is we'll wait for things to recover and wait for things to get better before we buy more again. Unfortunately, we're obviously only going to be buying things more. We're going to be buying more of the stock market at a higher price if you wait for it to recover.
Speaker 2:So if the stock market was at 100 in your life and it went down to 50 and you didn't buy, then it goes from 50 back to 100. Just remember what's happened is it's doubled and then you decide to buy because it's now back at where it was when you started. That's not a good call. So a strategic asset allocation for yourself and then discipline rebalancing on an annual basis is a massive key to long-term investment success. It prevents you from earning too much of something when it gets too expensive and forces you to buy something when it's cheap and offering great value. So I hope that helps and thank you for your questions. Please keep them coming.
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