Intro. to InvestingDiversification

09/05/13

 

• Diversification• “Most Hated Stock-Market Rally in Years Goes On”• What do we think

Studies show that somewhere between 77 and 94% of the variability in your portfolio's returns are determined by asset allocation

What is diversification?

“… we're referring to the attempt by the investor to reduce exposure to risk by investing in various companies across different sectors, industries or even countries.”

- Most investment professionals agree that although diversification is no guarantee against loss, it is a prudent strategy to adopt toward your long-range financial objectives.

- to put it simply by spreading your investments across various sectors or industries with low correlation to each other, you reduce price volatility.

- Reduction in volatility because of the combination of possible low or negative correlation investments

Asset allocation

- There is general agreement that asset allocation is the most difficult part of portfolio management

- Life is always about risk and reward

- It's all about not having all your eggs in one basket

- "But in order to diversify correctly, you need to know what kinds of investments to buy, how much money to put into each one, and how to diversify within a particular investment category."

- Go for Variety, Not Quantity

- Having a lot of investments does not make you diversified.

- To be diversified, you need to have lots of different kinds of investments. That means you should have some of all of the following: shares, bonds, property, international securities, and cash.

The key is having the right mix of shares, bonds and cash.

This mix of asset classes is known as your “asset allocation”

Risk/ Return trade-off

Historical returns

For asset allocation to work you need time for the asset classes to “do, what they must do.”

“Time heals most wounds!

Asset Allocation

“Ok, Mark, I understand splitting up my investment pie but what are my options?”

The four major asset classes you typically invest in:

Cash (or cash substitutes) gives you and your portfolio security and stability.– lowest risk, short-term horizon

Bonds brings in income – low to medium risk

Property provides both a hedge against inflation and low "correlation" to stocks – medium to high risk

Equity helps your portfolio grow – high risk, long-term horizon

International investments provide growth and help maintain buying power in an increasing globalized world

Also remember:

- What is your time horizon

- What is your appetite for risk

- Do you need income from this investment

Stocks. Bonds. Cash. Others. What is the right mix?

Should my asset allocation change as I get older?

Absolutely! That's because different investment mixes are riskier than others, and your tolerance for risk decreases as you age.

What's the best asset allocation for my age?

"The old rule of thumb used to be that you should subtract your age from 100 - and that's the percentage of your portfolio that you should keep in stocks.”

For example, if you're 30, THEN 100 – 30 = you should keep 70% of your portfolio in stocks. If you're 70, you should keep 30% of your portfolio in stocks.

However, with investors living longer and longer, many financial planners are now recommending that the rule should be closer to 110 or 120 minus your age. That's because if you need to make your money last longer, you'll need the extra growth that stocks can provide.

Risk Return Trade-off

CPI+

5%

CPI+

7%

CPI+

4% CPI+

6%

CPI+

3%

77

57

433221 Risk

Retu

rn

Cash/Cash equivalents

Equities

Cash Bonds Prefs Property Alt. Inv Equities

Vunani Private Clients asset allocation

Moderate Growth CPI + 5%

Aggressive Growth CPI + 7%

Conservative GrowthCPI + 3%

Selective Weighting:

Equities (Dom.) 8%Bonds (Dom.) -4%Cash -3.5%Equities (Int.) +2%Offshore Bonds -5%

VPC Portfolios

"This is ridiculous, Pisani!" they say.

"It makes no sense. You can't possibly think you could explain this."

Bob Pisani

“Here's What's Behind the Stock Market Rally”

Massive liquidity,

+ Search for yield (higher demand for stocks),

+ Modestly higher (record) earnings,

+ Heavy stock buybacks (constricting supply),

+ Heavy Fed bond buying (constricting supply),

= A stock squeeze!

Performance - April 2013

Resources Industrials Financials

-8.52% -0.08% 0.08%

Top40 forecast

Expected 12-month equity performance (All Share)

-10%

0%

10%

20%

30%

40%

Base case Bull case Bear case