You have to be in it to win it!

24 Apr 2013

By Shadforth Financial Group

There's no such thing as a free lunch in business—but diversification offers the closest thing in investment. This is because asset classes perform differently during different phases of the economic cycle and security-specific risk can be minimised by holding a spread of different investments. Sometimes we need patience as well as diversification to reap the benefits.

Investors starved of returns would do well to remember this when considering how to respond to the recent climate of gloom and uncertainty. So often the investment cycle appears to be either famine or feast and until the last nine months the pickings were looking pretty slim.

The global economic crisis was so severe that the United States (US) Federal Reserve cut interest rates over the past few years to unprecedented lows. Such aggressive cuts in rates have not been seen in nearly half a century and represent a chilling response to the fall in consumer confidence, cuts in business production and rising levels of unemployment.

For those feeling anxious, it is important to remember that it is always darkest before the dawn. We are not out of the woods yet— by a long shot. For those who had previously been gorging on unsustainable returns, the last five years of less substantial (even meagre) offerings leaves a rather unpleasant taste.

The solution is to follow a well-balanced diet comprising the essential elements for a vibrant and healthy portfolio.

The five essential groups are:

  • Australian shares
  • International shares
  • Property
  • Interest-bearing securities; and
  • Cash.

It might sound bland and boring, trimmed of the excesses and marketing hype served up by many in the financial services industry, but deep down we all know that if our investments are to grow big and strong, we must have a staple diet. Once you have addressed this fundamental issue you can reward yourself with the occasional treat.

Perhaps a small serving of higher-risk alternative assets can be allowed. A little bit extra on the side, such as hedge funds, emerging markets, venture capital or a high-yield investment fund can spice things up. Just be careful not to overindulge.

I often like to refer to the Rule of 72 as a way to make the medicine a little more palatable. This rule is an excellent way to measure your progress over time. Stated simply, you can predict how rapidly your money will double by dividing the annual return into the number 72.

For example, if you achieve a compound return of 8% a year (reinvesting earnings) your money will double every nine years (72 divided by 8 = 9).

So $100,000 becomes $200,000 in nine years and $400,000 in 18 years.

The 8% may be a reasonable average to assume for a diversified portfolio over time but there can be long periods of negative returns as well as super high returns over relatively short periods in a recovery phase. You have to be in it to win it!

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