Once you’ve decided to start an investment portfolio, the next step is to decide what to invest in. The average person will pick a handful of stocks and hope for the best, here we explain some more sophisticated techniques for constructing your investment portfolio.
Asset Class Selection
Your first decision is which asset classes to invest in. Your broad choices are set-out below, each week we are going to delve into one of the asset classes and explain exactly how you can invest in it, and why you may want it to form part of your portfolio:
|Asset Class||Prupose||Risk||Time Frame||Products|
|Cash||Keep some money available for short term cash needs||Low||Short term||High interest savings accounts, term deposit, cash exchange traded funds|
|Bonds||Earn some interest while keeping risk low||Low – High||Short to medium term||Government bonds (low risk) to junk bonds (high risk). Bond exchange traded funds, actively traded bond funds|
|Property||Earn income via rent and increast the value of your investment over time through property price increases||Medium – High||Medium to long term||Directly through purchasing a property. Indirectly through a property exchange traded fund, a property managed fund, or through shares in property companies|
|Australian Shares||Earn income via dividends and increase the value of your investment over time through share price increases||High||Medium to long term||Direct shares, equity exchange traded funds, equity actively managed funds|
|International Shares||Increase the value of your investment over time and spread your risk globally, rather than being concentrated in the Australian market only||High||Medium to long term||Direct shares, equity exchange traded funds, equity actively managed funds|
Investment Style: Passive or Active
Your next decision is which investment style you prefer:
Active Management: Active managers believe that they can outperform the market by picking the best investments. Active managers are likely to charge a higher fee for this skill.
Passive Management: Passive managers believe that it is not possible to beat the market. Instead of picking individual stocks, they believe it is better to be invested in the whole market. Passive management fees are lower than that of active managers.
Your decision about investment style will determine how you invest. If you believe in active management then you can either:
Do the research and make the investments yourself – we only recommend this if you feel confident that you have the time and technical skills required to do the necessary due diligence on each investment, and that you have some kind of advantage (e.g. in depth knowledge of an industry) over professional fund managers.
Pay a fund manager – You can outsource the investment decision by paying a fund manager to manage your money. The cost is typically 1 – 2% of the amount that you invest.
If you decide to follow a passive investment strategy then your main investment tool will be exchange-traded funds (“ETF”). An ETF gives you access to an entire market (e.g. the top 200 shares in the Australian market, known as the ASX200) through one single purchase on the stock exchange. Fees for an ETF are lower than for an actively managed fund, they are more likely to be between 0.10% – 0.50%.
In deciding whether to follow an active or a passive strategy, it is worth considering this semi-annual report by S&P which shows that in most asset classes, the majority of active managers do not beat the market. This report suggests that a passive management style can potentially be better for your portfolio. The key exception is in Small Cap stocks (i.e. smaller companies listed on the stock exchange) where it has been shown that 60% of Small Cap fund managers have outperformed the market over the last 5 years.
The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs and before acting on the advice.