Asset Allocation: Jan 2008

My Total Assets at the start of 2008 were worth approximately $2,065,876 with debts (margin loans and mortgages) of $932,963, giving a net worth of approximately $1,132,913. The overall level of gearing is a reasonable 45.2%, or a debt:equity ratio of 82.4%.

Overall asset allocation was;

Cash 2.4%
Australian Stocks 40.1%
International Stocks 10.2%
Hedge Funds 5.0%
Property 42.3%

The allocation to property has decreased from around 50% a few years ago, as we haven't bought more property, my savings have been directed into other asset classes, and the Australian stock market had performed strongly over the past four years while the property market was subdued.

I would like to accumulate about 10% of my assets in bond index funds as this asset class is almost non-existent in my portfolio, but it just doesn't seem to make sense for me to invest in bonds in my geared investment accounts where the margin loan interest rate is likely to average more than the bond yield. It would seem more sensible to pay off the margin loans than invest in bonds, but I'm happy with my overall levels of gearing (around 50% in my non-retirement investments), so I'm stuck with investing in equities and hedge funds via my geared investment accounts.

I haven't included relatively small investments I have in agribusiness funds, coins and bullion. I also haven't allowed for any tax liability, mostly because current tax laws will make income and realised capital gains in my retirement account tax free during the pension phase, and if I liquidate my non-retirement holdings during my retirement years my marginal tax rate will be fairly low, and long term capital gains are only taxed at half the marginal tax rate. I also haven't even considered any possible inheritances I may receive during my retirement years.

Copyright Enough Wealth 2007

My Portfolio's Asset Class Returns over Past Three Years

Over the past three years my overall networth has increased by an average of 17.1%pa. However, this is a true "return on investment" figure as it includes annual additions to my savings (via mortgage repayments of principal and additions to my retirement account) of around $30K pa. Allowing for this my overall ROI over the past three years is around 13.7%, which is still very good. My long term target is to achieve a "real" ROI around 5-10% pa.

Comparing my three main investment categories (real estate holdings, stock investments, and retirement account I find that my real estate equity has shown an average rate of increase of only 5.6% pa during this period. Even this figures is inflated as it includes a reduction in my outstanding mortgage of over $15K. I'm not surprised by this result as the Sydney real estate market has been very flat since the last property "bubble" burst in 2002. Fortunately our two properties are in the upper-middle price range, which hasn't fared as badly as the botom end of the market. I expect that the Sydney property market may improve over the next three years as there is considerable pent-up housing demand which is starting to spill over into very low vacancy rates and increasing rents. This improvement may be delayed if there are another couple of interest rate rises over the next 12 months.

My stock portfolio has had a terrific run over the past three years. This is to be expected with the All Ordinaries gaining around 15%-20%pa each of the past three years. Combined with a moderate level of gearing via margin loans my stock portfolio has averaging an increase of 30.7% pa. Stock purchases have probably balanced out with stock sales (takeovers etc) during this period, so this is probably close to the true ROI achieved.

My retirement account has grown by an average of 17.1%pa over the past three years, but this has also been boosted by a relatively high rate of additional savings via employer contributions and salary sacrifice.

For fun I did a calculation of where I'd now be if I hadn't bought the second property and had instead kept the additional funds invested in the stock market. It turns out I'd now have about an extra $200K in net worth and my overall ROI would have been around 17.1% rather than 13.7%. Looking on the bright side at least I didn't liquidate all my stocks back in 2002 and invest in a rental unit, or kept my money in a bank account.

The lesson out of all this is that it generally isn't possible to pick which asset class will do best over the next 3, 5 or whatever period. So it's best to maintain a diversified portfolio spread accross the asset classes, in whatever proportion suits your personal risk tolerance and return expectations. That way you're most likely to achieve the results you want with the least possible volatility in portfolio value.

Copyright Enough Wealth 2007

My Overall Asset Allocation Update: 22 Oct 2007

Asset allocation has changed slightly since the last update due to the transfer of our retirement funds from our employer's superannuation fund into our own SMSF. The transfer resulted in a large cash balance, which is slowly reducing as we invest the funds into the Vanguard LifeStages High-Growth Index Fund over several months using dollar cost averaging.

According to my asset allocation records my net worth is currently $1,174,609 (this figures is slightly higher than my NetWorthIQ figure as it includes a small coin collection and some bullion that isn't counted in my monthly NetWorthIQ updates). This figure derives from a total asset valuation of $2,146,371 and debts of $971,762.

The debts can be broken down into $363,000 real estate mortgages, $229,491 in a "portfolio loan" used for some stock investments and secured against my real estate equity, $268,718 in margin loans, and $89,840 in miscellaneous debts (0% CC balance transfers, hedge fund investment loan etc.)

The overall Loan to Value Ration (LVR) is 45.3% (the ratio of debts to asset valuation), and the overall gearing level is 82.7% (debt:equity ration, or debt:NW ratio). My long term target is to maintain my LVR around 50% (ie. gearing around 100%) while working. This boosts overall ROI (provided investment total return (income + capital gains) exceeds borrowing costs), but also is a useful tax management tool via negative gearing (which effectively converts income into long term capital gains, which has a lower tax rate).



Copyright Enough Wealth 2007

Decisions, decisions

The funds in our SMSF bank account have finally cleared, so I was able to transfer $330K into the investment sub-account which is used to settle any e*Trade transactions. I can now apply via e*Trade to make our initial investment into the Vanguard LifeStrategy High-Growth Fund. Of course I don't know if the unit prices will go up from here in the short term or maybe drop even further, but at least I can be 100% sure that the current price is around 10% off its peak from earlier in the year, and that we gained a couple of percent by being in cash for the past two weeks. I'm sure that in 20 years time the current dip won't even be noticeable in the chart. The important thing is to be invested in our chosen asset allocation and remain invested for the next 20 years. One good thing about investing all our SMSF funds in the one fund is that rebalancing between the underlying asset classes should be done automatically by Vanguard to stay close to the target asset mix for this fund. This is even better than using a mixture of Vanguard Index Funds to achieve a desired asset mix because rebalancing between funds would cost the 0.5% buy-sell spread in unit prices, although since rebalancing would generally only require a small fraction of the total investment to be moved, the effect would be negigible. All we need to do on an ongoing basis is to periodically adjust our automatic investment plan to reflect the amount of money we are depositing into our SMSF bank account each month via salary sacrifice and the SGL contribution from our employer.



Copyright Enough Wealth 2007

Why I Don't Worry about Rebalancing my Asset Allocation

In an ideal world my investment asset allocation would be done in the following manner:
1. Determine what initial amount to invest and ongoing savings plan
2. Determine my risk tolerance and any constraints regarding what investment types I choose to invest in (eg. ethical funds, hedge funds etc)
3. Decide my timeframe and investment targets (eg. final amount for retirement, target ROI or whatever)
4. Select an appropriate asset allocation to meet my investment return target with minimal risk (ie. aim for the efficient frontier)
5. Select individual investments to meet my overall asset allocation with consideration of fees, diversification.
6. Rebalance the investments periodically (eg. every year) or when the actual asset allocation differs too much from the target allocation - either by selling investments and reinvesting, or by adjusting what assets new savings are directed into. Bearing in mind transaction costs and capital gains tax effects.

In reality I have a ROI target of 5%-15% for my total networth, excluding annual savings of around $30K. Assuming a CPI of 2%-3% this would mean a real return of around 2% - 12%. But I don't have an overall asset allocation target as I have a large chunk of my net worth tied up in real estate via our home and our rental property, despite preferring to be largely invested in Australian and international shares. The rental property investment was mainly chosen because DW wanted to invest in the property market, and the house - well we both prefer to own our own home rather than rent. I therefore tend to only manage asset allocations within our superannuation account and by having the remainder of my investible assets in stock investments plus some alternative investments (hedge funds, agricultural investments, coins, bullion etc). Given that I have a much larger proportion of my assets in real estate than I would prefer, you'd expect that any additional investments would have been directed towards additional stock purchases, or perhaps some alternative investments. In reality although my personal savings have been directed towards direct stock investments or into my superannuation fund, until recently we had actually been increasing the proportion of our networth tied up in real estate due to our home loan payments reducing the property loan principal over time. We've now got both our home loan and rental property loan setup as "interest only", mainly because DW can't afford her half of the normal P+I loan payments while working part-time, so this will shift our asset allocation
more towards stocks over time.

As you can see, my overall asset allocation is therefore a pretty hit-and-miss affair. So for that reason worrying about fine-tuning asset allocation by rebalancing is a moot point.

Copyright Enough Wealth 2007

Net Worth Update: Jan 07

The past month provided more good gains in my stock portfolio and retirement account, offset only slightly by a small drop in the valuations of my real estate assets:
* Average property prices were slightly down, dropping my property equity by $4,146 or 0.58%. We also had to redraw $3,500 from our home loan prepayments to meet our repayments as DW is on maternity leave and not earning any income at the moment.
* My stock portfolio equity went up another $19,568 (5.50%) this month and my retirement account also increased significantly, although it was boosted a bit by some extra contributions being deposited by my employer this month - up by $12,561 to $324,598 (up 4.03%).

My Networth as at 31 Jan now totals $1,058,372 (AUD), an overall increase of 2.48% for the month.

As discussed in a previous post, I'm looking into either buying Index Put options to protect against significant losses if the market drops, or else selling off some of my stocks to repay my margin loans and eliminate my gearing while the market is at the current high level. I'm leaning towards the Put Options idea as I don't want to realise capital gains this financial year, and most of my margin loans have had the interest prepaid until 30th June, so I should keep my investments until then (and keep my fingers crossed that the market goes up a bit more until then).

Is it Time to try Timing the market?

Although my preferred strategy is a "high-growth/high-risk, buy-and-hold, stick to your asset allocation" one, there comes a time when the market starts to look a bit too high to any dispationate observer. The pundits are still saying that the Australian stock market isn't cheap but isn't too expensive either, based on historic p/e ratios and company profitability outlook. Then again, they're saying that after three consecutive years of total returns of 20%+ the best they expect this year is around 10%, so the upside seems limited, while the downside risk has obviously increased from what it was four years ago. Looking at the chart for the All Ordinaries Accumulation Index since 1980 the current market rise looks a lot like 1987 - and we all know how that ended up!



Anyhow, the Superannuation (retirement) account for my son was invested with the following asset allocation:

80% Geared Australian Share Fund
20% International Shares Fund

This allocation has performed very well since I opened his account four years ago, with returns of:

FY 04/05     25.3%
FY 05/06     42.0%

I figure that having gotten off to such a good start DS1 can now afford to move to a more conservative, high-growth asset mix (even though at age 6 he has another half century before he reaches retirement age), so today I sent in the paperwork to change his investment mix to:

30% Australian Share Fund
10% Australian Small Co Share Fund
20% International Shares Fund
20% Property Securities Fund
20% Australian Bonds Fund

This is still a high-growth, high-risk allocation (with 60% in stocks) so it should provide a good rate of return over the next 50 years, but at lower volatility than the previous asset mix. If there's ever a significant (30%-50%) correction in the Australian Stock Market I'll think about moving some funds back into the geared Australian Share Fund again. I think this weak form of market timing is called "dynamic allocation" - but it's still just a guess no matter what you call it.

 *    *    *    *

The current market also has me a bit nervous about my Australian Share Portfolio. I have two margin lending accounts holding $540K of Australian Shares, with a loan balance of $263K, so a severe market correction would have a big impact on my Net Worth! I'm toying with the idea of buying some PUT options on the ASX200 Index as insurance against a major market correction occurring between now and the options expiry date (21 June 2007). For $12K I could buy enough Options to offset any losses where the market drops below 5500 (it's currently at about 5750). The simpler option (excuse the pun) would be to just sell off enough of my portfolio to pay off the margin loan balances - but the interest has been pre-paid until 30 June 2007, so I'd be throwing five months of interest payments down the drain if I paid off the loans now. I also have reasons for not wanting the realise a capital gain prior to 30 June.

Current Asset Allocation

I checked on all my accounts to determine my current overall asset allocation (if it was way off what I want I would think about rebalancing). The Net Worth figure is slightly higher than my usual monthly calculation as this one includes some items I don't normally bother with - bank accounts, coin collection/bullion, and agribusiness investments. The total still doesn't count miscellaneous household items or cars, boats, hovercraft, steam engines etc. (see previous post on "toys"):

Overall Asset Allocation  
                  %          $
Assets         100.0%   $1,814,373.92
Debts                     $711,224.31

Asset Allocation:  

Au Shares       38.3%     $694,875.45
Int Shares      11.6%     $210,337.08
Property        41.2%     $747,988.85
Fixed Int        1.5%      $28,071.17
Hedge Funds      5.0%      $90,448.50
Agribusiness     1.2%      $22,650.00
Coins/bullion    1.1%      $20,000.00
  
Net Worth               $1,103,149.61
LVR (D:A)       39.2%
Gearing (D:NW)  64.5%

Accounts:  

Retirement                $312,446.13
Direct Property           $713,750.76
Margin/Broker             $670,449.34
Agribusiness               $22,650.00
Coins/bullion              $20,000.00
Hedge Funds                $50,000.00
Bank Accounts              $25,077.69

This year I'll continue building up my "Little Book" portfolio of US stocks, which will increase my allocation to International shares to around 15%. I don't plan to invest any more in real estate, so my allocation to property should drop below 40% soon. In the longer term I'd expect my allocation to drift towards 35% Au stocks, 20% Int stocks, 35% property, and 10% "other". I aim to keep my use of gearing to around 40% LVR (67% gearing).