Lately, I have come across many “investors” who are experiencing significant losses on their investments, either due to the current bear market or the underperformance of their investment. And because of this, many book readers have approached me, worried about their investments. The most frequently asked question I encounter is: “How do I make money on my investments during a tough market like this?”
I find it gratifying when individuals approach me with an awareness of the significance of investing and have already undertaken the necessary steps to grow their wealth. However, as an investor, it is crucial to grasp the fundamental principles behind investing to achieve the desired outcomes.
Given this perspective, it is worth considering an alternative approach for investors. Instead of fixating on the question of how to make money, investors should ask themselves – what asset classes are they investing in and how are they allocating their money?
The question itself is a game changer for investors, yet it is a step that many people seem to overlook.
Here’s the thing, many investors start out making a bold move to grow their money. Later, as time goes by, they neglect revisiting their investments to understand how their money is working for them. In some cases, this oversight can prove even more detrimental than not investing at all, particularly if the investment consistently underperforms and in doing so, depletes your financial assets.
As a licensed fee-charging financial advisor, I often find that clients tend to focus on investing in certain stocks, mutual funds, or chasing after trending investments without considering the bigger picture of their overall portfolio.
If you are young and in your late 20s or early 30s, this may be still acceptable. However, if you’re in your 40s onwards and preparing to save for retirement, this is not a time to take risks and make uncalculated decisions with your money.
To ensure that you always have a steadily growing investment portfolio, it is imperative to maintain a well-balanced investment portfolio. The key is understanding the concept behind asset allocation, as it is one of the best tools a long-term investor can leverage on.
If you are not already familiar, asset allocation entails the division of an investment portfolio into various asset classes, such as stocks, bonds, REITs and cash. This strategic approach aims to optimize returns while minimizing risk. In this article, I will delve into the significance of asset allocation and provide guidance on where to start to ensure your wealth is growing steadily.
Why is asset allocation important?
In essence, asset allocation serves as a crucial mechanism for investors to achieve their financial goals while significantly mitigating risk. By diversifying their investments across various asset classes, investors can diminish their exposure to any individual asset class, sector, or market.
Let’s take for example the case of Robert. Robert has heavily invested in the property market. Having purchased and leased more than 10 properties under his name, Robert witnessed his net worth grow through rental income as well as the appreciation in property value. However, in 2020, Robert faced a significant challenge as he lost almost all of his tenants, leaving him responsible to bear all the loan repayments on his own.
While the government initiatives initially aided in mitigating some of the losses, Robert began to feel the impact once these subsidies stopped. He struggled to find tenants and found his own emergency fund depleting quickly. To quickly recover from this, Robert had no choice but to sell off three of his properties in order to generate cash flow to support the remaining properties. Unfortunately, due to urgency to sell, he had to settle for an average drop in value of 40%, resulting in a significant setback.
From the example above, it becomes evident that Robert faced significant consequences when he concentrated his investments exclusively in property, putting all his eggs in one basket. When the property market crisis hit, there was a significant impact on his wealth portfolio. However, by diversifying across different sectors and asset classes, Robert could have limited the impact of the fallen property market, and buffered that loss through his other investments that were likely to increase in value during that time.
To put it simply, asset allocation is a fundamental long-term investment strategy that helps investors maximise their returns over time. This is because different asset classes have different risk and ROI potential, and thus investing in more than one asset gives you a higher chance of having growth in your portfolio. For instance, stocks are generally considered more volatile than bonds, but they also have the potential for higher returns. By including both stocks and bonds in a portfolio, investors can strike a balance between risk and their ROI, potentially achieving higher returns in the long run than they would with a portfolio that only contains one asset class.
Another important aspect of asset allocation is that it can help investors stay disciplined during market downturns. When the market experiences a downturn, investors would tend to panic and hastily sell their investments. However, if an investor has a well-diversified portfolio, they may be less likely to panic and sell their investments because they understand that the strategy here is to keep their portfolio balanced. Staying focused on balancing your portfolio will keep you away from detrimental and emotional decisions based on the “noise” that we hear from current investment news. This way, investors may be able to avoid selling at a loss and potentially capture gains when the market eventually recovers.
When building an asset allocation strategy, there are several key aspects that investors should consider:
- Risk Tolerance: Risk tolerance refers to an investor’s willingness and capacity to take on risk. Some investors may be comfortable with higher levels of risk in pursuit of potentially higher returns, while others may prefer a more conservative approach. If you’re single and unmarried, you may be able to take on a higher risk-reward portfolio than if you are planning for your children’s future. It is important for investors to understand their risk tolerance in order to know their baseline when building a portfolio that is appropriate for their needs.
- Time Horizon: Time horizon refers to the amount of time an investor has to achieve their financial goals. Investors with longer time horizons may be able to tolerate more risk than those with shorter time horizons. A young investor who is saving for retirement will have a longer time horizon to build and accumulate wealth, thus they will also have room to tolerate some losses along the way.
- Investment Objectives: Investment objectives refer to an investor’s goals for their investments, such as capital growth, income generation, or capital preservation. Different asset classes align with varying investment objectives. For example, stocks may be more appropriate for investors who are seeking growth, while bonds may be more appropriate for investors who are income oriented.
- Diversification: Diversification involves spreading investments across a variety of assets in order to reduce risk. Investors should aim to diversify their portfolio across different asset classes, sectors, and geographic regions. By diversifying, investors can minimize their exposure to any single asset, sector, or market.
- Selecting Quality Investment: When you’ve determined the asset classes and how you’ll be diversifying your portfolio, it is important to then compare the investment options in each of your asset classes to select the best quality investments. To do this, you may adhere to the SRB approach that I’ve shared in my previous articles and also in my latest book, Financial Freedom Investing. The SRB approach emphasizes the importance of selecting investments that are safe (S) and regulated by securities commission, investments that rise (R) in the long term and investments that are best-of-breed (B) when compared to others of the same asset class. I have seen many cases where my client’s portfolio could have performed at least 50% better in ROI if they had selected the right investments based on the SRB.
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Maintaining your asset allocation
Your job doesn’t end once you have constructed an investment portfolio based on the desired asset allocation and selecting the best quality investments. You need to ensure that your asset allocation stays the same, through a process that is called Rebalancing.
Rebalancing refers to periodically adjusting a portfolio to align with your desired asset allocation. As time goes by, different assets will perform at different rates, causing your portfolio to fall out of its original asset-allocation ratio. This is when we need to review and rebalance our investment portfolio regularly to ensure that our strategic allocation remains intact and relevant. I recommend conducting this process at least once every 6 months or when the portfolio deviates by more than 10% from of its original ratio.
Conclusion
Asset allocation is the key to building a successful investment strategy for long-term investors who want to see their wealth grow steadily over time. While it may take a lot of initial research and effort to determine the right asset allocation and risk tolerance for yourself, the long term reward is worth the effort put in.
If you find yourself lacking the time or expertise to establish your portfolio, monitor it consistently, and rebalance when necessary, consulting an experienced and licensed fee-charging financial advisor is your best course of action. They can guide you through the process and ensure that your wealth steadily grows over time, enabling you to realise your financial aspirations.
Yap Ming Hui is a licensed financial planner. The views expressed here are the author’s. Any reliance you place on the information shared is therefore strictly at your own risk.
The article is featured in The Star Online, at the following link: Allocating investment assets for steady growth | The Star