Stephen Bland shares his views on the thorny topic of asset allocation.
I decided that I'll give it some verbal this week for a change. All that math about P/E etc. over recent weeks in writing about individual potential value plays has been making what passes for my brain hurt.
The topic then is asset allocation. This probably means different things to different people, in particular to the institutional investor compared with the individual private investor. It is though the latter with which naturally I am concerned here.
Put simply, this comes down to a clichéd eggs and baskets decision. How many eggs, how many baskets? It assumes that the investor has the luxury of choice. Most don't really. If you are a young person struggling with a mortgage and the rest of it and have say a couple hundred or so per month to invest and no lump sum, then you can't really spread it around too much in any case.
Personally, I don't see the need for wide diversification between different classes of investments for most people. There are probably three main areas of long-term places to stick your money. Shares, cash and bonds, property. I know there's other fringe stuff like wine, gold bullion and so on but I don't see these as serious contenders for most peoples' money. More like a mug's game for most I suspect, operated by often dodgy outfits.
I am here excluding deliberately the sort of packaged investment products of various types marketed by insurance companies because I believe that these should never be considered at all by any investor, whatever the amounts of money available, small or large. My view is that these schemes insert an unnecessary barrier, and therefore risk, between investors and their money for which handsome charge is made and which too often fail to deliver a commensurate return. On the contrary, they have frequently been characterised by scandalously poor performance. In the guise of offering lower risk investments, I see them as the opposite, actually increasing risk over the alternatives. Avoid them.
Direct investment in property, whether residential or commercial can involve a lot of hassle, especially residential. Most commercial property is let so that the tenant is responsible for maintenance. Not so for residential where every little problem that arises will be the landlord's responsibility. Many investors in the latter employ agents to take care of all that for them but there is a significant cost involved plus the obvious risks of void periods, dodgy tenants etc.
Nevertheless property can be very rewarding over the long term on the capital side. Just look at the price of most houses now compared with, say, twenty years ago. Also there is the availability of loan finance for this. So there are likely to be some compensating rewards for the hassles, risks and illiquidity involved. Some people too find the fact that property is tangible, i.e. you can kick it, reassuring in a way that paper investments can never be.
In contrast, investments like shares, cash and bonds though intangible avoid the complication of having to do much to maintain the investment and are totally liquid. Cash on deposit is even simpler. You go for the highest interest and stick only with large, reputable banks. Don't be tempted by much higher rates offered by some questionable deposit takers, the risks are probably not worth it.
I have found from advising investors that asset allocation often comes down to an emotional reaction based around perceived risks, particularly with shares. Many see shares as far too chancy, little more than outright gambling, and have difficulty in consequence considering this avenue, especially those with a substantial lump sum available. In the past, this sort of investor would usually stick with deposit accounts or, regrettably, insurance company schemes, though I think my High Yield Portfolio strategy has rescued a few from the latter fate.
In conclusion, my view is that the need for diversification by the private investor is often over stated by commentators. Most investors will have their own home anyway so they already have a stake in the property market. After that I think that a clear, single-minded strategy based on your personality is the way to go but make sure you try to establish a realistic view of the comparative risks of alternatives, not false perceptions.
You don't in my view need diversification for the sake of it and can hedge too much with the result that you actually worsen your chances of making any decent overall returns long term.
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