By Sheryl Sutherland*
‘She who puts all her eggs in one basket ends up with egg on her face.’
- Old Chinese saying
New Zealand investors should diversify by investing overseas. Diversification is simply spreading your investments to help cushion the effects of market volatility. It also assists in that no one investment is the perfect investment, sometimes one asset class or investment outperforms another.
Our share market is tiny compared to world standards and doesn’t fully participate in the profits made by other economies, countries, and sectors. Diversification should include not just asset classes, but countries and companies.
One of the dangers of diversification is ‘diworsification’, also known as ‘too much of a good thing’. Including all sectors in your portfolio can dampen the return you get. If you are investing for the long-term, rather than put your eggs in all the available baskets, you need to select carefully just which baskets will give you the best return; a process known as asset allocation.
Asset allocation is the most vitally important part of your investment portfolio. This is one of my favourite topics, especially as I don’t always agree with conventional wisdom. It has been well documented that 80% of your return comes from correct asset allocation.
Wisdom also suggests that if you have an investment portfolio with share market exposure, you should have exposure to other asset classes so that when shares give negative returns other noncorrelated investments will perform.
So, what exactly would be the optimum portfolio for a long timeframe? I recommend using passive investments as a core portfolio for efficient markets. Active and passive investing are not mutually exclusive. Active managers take a more hands on approach creating value through the selection of individual management styles and selection of individual assets. In my view active managers are ideally suited to volatile or new markets for example India, China and Infrastructure.
Even Warren Buffett promotes passive indexing (perhaps the ultimate example of do as I say, not as I do in the investing world). From 2009 until today passive investing’s share of assets has increased from about 20% to around 50%. Ultimately it can create market distortions, the equivalent of the weak players leaving the poker table.
Against this, active management provides price discovery and liquidity however fees are generally higher for active managers than passive ones, there is a cost to assessing value ahead of time. Still average fees for the industry have declined as the result of the rise of passive indexing. An additional argument for utilising active fund managers is the rise of passive investors which can have the effect of leaving the weakest player at the poker table.
*Sheryl Sutherland is director of The Financial Strategies Group, and author of Girls Just Want to Have Fund$ – Every Women’s Guide to Financial Independence, Money, Money, Money Ain’t it Funny – How to Wire your Brain for Wealth, and co-author of Smart Money – How to structure your New Zealand business or investments and pay less tax. You can contact her here.
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