Portfolio Construction – Part 3

This post is the last in the Money Master Class series – well done for making it to the end!

This post is the last in the Money Master Class series – well done for making it to the end!

We’ll then be taking a few weeks off from the blog, because we are about to launch the online ethical investing portal, yay!

We covered a lot last week, so this week we thought we’d go through some worked examples to show how the theory can be put into practice.

 

Example 1: Saving for the long-term

Peter

Age 25
Starting Investment amount $5,000
Target Investment amount $200,000 in today’s dollars
Cash needs over next 3 years $0
Investment Time Horizon 10 years
Investment Purpose First Home

 

Peter is 25 and has $5,000 in savings.  By the time he is 35, he would like to buy his own home, either to live in, or as an investment.  He thinks a deposit of $200,000 in today’s dollars will be enough for a 20% deposit on his chosen property.

He will not need to access any cash from the savings in this account in the next few years.  Peter is a risk taker and is comfortable taking on the risk of losing money every 4-5 years, because he really wants to maximise his return. 

Peter decides to invest his money in 80% growth assets, and 20% in defensive assets and selects:

Asset Class Percent Amount Estimated Return
Cash 5% $250 2.50%
Bonds 15% $750 4.00%
Shares 80% $4,000 8.00%
Estimated Weighted Return 7.125% p.a.

 

To estimate return, Peter uses a lower rate of return than historical rate of returns, due to the current low interest rate environment.  He will revise his estimated returns by asset class each year, based on current economic conditions.

Calculating Target Investment Amounts

In 10 years time, Peter estimates that $200,000 in today’s dollars will be equivalent to $256,000, using an inflation rate of 2.50%.  Therefore the target at the end of 10 years is $256,000.

If his investments earn 7.125% p.a, peter will need to save $1,400 per month to reach his goal at the end of 10 years.

Choosing Investments

Given his small starting investment amount, and relatively small monthly contributions, Peter decides to invest using exchange-traded funds.  He invests in:

  • 5%                          Cash in a high interest savings account

  • 5%                          Government Bond Fund ETF (very low risk)

  • 10%                        Corporate Bond Fund ETF (medium risk)

  • 40%                        ASX 200 ETF (high risk)

  • 40%                        International Stock market ETF (highest risk)

Peter will monitor the performance of his portfolio via his brokerage account, and intends to check the performance monthly and rebalance his portfolio allocation annually.

Example 2:  Investing for Income Needs in Retirement

Marie

Age 60
Starting Investment amount $500,000
Cash needs over next 3 years $90,000
Investment Time Horizon 30 years
Investment Purpose Retirement Income

 

Marie is 65 years old and has recently retired.  She has paid off her mortgage and has estimated that she will spend $30,000 per year in retirement, and that she will live to 95. 

Based on her calculations, she would like to earn 5% a year on her investments.  Marie is not a big risk taker, but she is worried about her money running out before she retires. Given that her total investment period is 30 years, she decides to invest some of her retirement funds in shares.  Marie therefore decides to put 60% of her money into defensive assets, and 40% into growth assets, split as follows:

Asset Class Percent Amount Estimated Return
Cash 18% $90,000 2.50%
Bonds 42% $210,000 4.00%
Shares 40% $200,000 7.50%
Estimated Weighted Return 5.13% p.a.

Choosing investments

When choosing her investments, Marie decides to put $90,000 in cash because she will need access to this cash to live on over the next three years.  She splits this cash between a high interest savings account and a series of term deposits:

  • 15,000                   High Interest Saving Account

  • 15,000                   6 month term deposit

  • 15,000                   1 year term deposit

  • 15,000                   18 month term deposit

  • 15,000                   2 year term deposit

  • 15,000                   2.5 year term deposit

  • 15,000                   3 year term deposit

She is concerned about fees, so decides to invest in both bonds and shares via exchange-traded funds.  She likes the idea of receiving dividends on her shares, so decides to put a portion of her investment into high dividend paying shares.  She invests:

  • 30%                       Government Bond Fund ETF (very low risk)

  • 10%                       Corporate Bond Fund ETF (medium risk)

  • 15%                       High Dividend ETF (high risk)

  • 15%                       ASX 200 ETF (high risk)

  • 10%                       International Stock market ETF (highest risk)

Marie will monitor the performance of her portfolio via her brokerage account, and intends to check the performance monthly, although she has decided to only make changes to her portfolio allocation and rebalance annually.

That’s it for the series!  We’ll be back in a few weeks for our next series, all about ethical investing.

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 before acting on the advice.