Investors often have no financial plan and have never considered an asset allocation model
KEY POINTS:
Too many Kiwis have all their financial eggs in one basket. Almost every week there are stories in the media of investors losing their life savings through finance and property company collapses and other financial catastrophes.
Out there in middle New Zealand are thousands more who are risking their financial future by failing to diversify.
The answer to this risk is to review your portfolio, allocating assets according to a formula that will ensure you don't lose your shirt if one investment falls over.
Kevin McCaffrey, chief executive of the New Zealand Shareholders Association, says all too often baby boomers come into an inheritance or other windfall and instead of educating themselves and investing it, they "lend it to a finance company" or put it in the bank rather than making active investment decisions.
These investors often have no financial plan of any sort and have never considered an asset allocation model.
Individuals who have found themselves with too little or no diversification have done so because they have taken a passive approach. They may be exposing themselves to huge levels of risk unknowingly - as did Blue Chip investors, who thought their investments were as safe as houses.
Others may have gone through the correct process once, but need rebalancing to revert to the original game plan. That happens because one asset grows ahead of the others, meaning that the mix of investments is out of kilter.
McCaffrey pays a financial planner to deliver him a five-year plan and recommends investors who don't have specialist knowledge do the same. Even so, anyone with money to invest needs to educate themselves financially and to understand the products their money is being invested in, he says.
But you need to choose your adviser wisely. Just going to a financial planner isn't always the answer because some planners are motivated by the commission rather than the client's best interests. Most recently, the ANZ came in for flak when it was revealed that its in-house financial advisers had been recommending that some clients put more than $100,000 in ING's Diversified Yield and Regular Income funds, which have since been frozen.
Likewise Blue Chip customers effectively put all their eggs in one basket on the advice of the company's "financial advisers", although it should be said that these people were actually salesmen and women, not trained financial planners who belong to the Institute of Financial Advisers or other trade bodies.
Broadly speaking, any investor who has more than 20 per cent of their portfolio in one investment ought to be asking questions, says Jeff Matthews, senior financial adviser at Spicers Wealth Management. For portfolios over $100,000 a red light should go on if you have more than 10 per cent in a single investment.
The answer, says McCaffrey, is to pay an upfront fee to a financial planner for an asset allocation plan rather than going to a commission-based planner. Many stock brokers and accountants offer a similar service. Fee-based financial planners will, if you take investments through them, and then rebate the commissions they receive.
Financial planners, says Acumen's Lisa Dudson, will often use an asset allocation model from companies such as Morningstar, which aren't available to the general public.
This will allocate a certain portion of a portfolio to cash, bonds, equities, and property (direct or indirect). The portions change according to an investor's time horizon and risk profile.
The mix of assets will be determined by a number of factors, including appetite for risk and the amount of time before the investor needs access to the capital.
A very conservative investor may have the bulk of their investments in cash and bonds, whereas at the other end of the scale, a very aggressive investor will have no or virtually no allocation to these classes and be more heavily weighted in local, international and emerging market equities and real estate.
Investors must understand their own risk profile before any asset allocation can be done, says Dudson. She regularly sees clients who want to increase their wealth rapidly, but are too risk-averse to stomach the rollercoaster ride that would be required to meet their goals.
Even once the allocation is done the question of product selection remains.
One of the difficulties in New Zealand, thanks to the high price of property, says Dudson, is how investment property fits the mix. The Morningstar asset allocation model may allocate 5-15 per cent to property, but if an investor has $100,000 equity in a property already and isn't going to sell, it can be almost impossible to get the allocation in balance. In that case, says Dudson, she will recommend that clients allocate their remaining investments to other asset classes such as shares and bonds.
She says it has been hard in recent years, as it was during the tech boom, to get clients to diversify their assets or understand the nature of the risks they take on.
Simon Hassan, president of the Institute of Financial Advisers, says members who review portfolios would consider:
What they want to achieve financially, and the time frame.
What other resources they may have, such as an inheritance in a few years' time.
Their attitude to risk.
Other issues, such as couples who have differing views on their finances.
Hassan says a financial plan could take anywhere between a few hours' work and a week, depending on the complexity. But for a couple with a house, investment property and perhaps a $100,000 term deposit, the fee would be around $3000 and would outline the review, specific recommendations and the reasoning behind it.
An existing client who needed a review would pay about $1000 to $1500 plus GST, says Phil Ashton, of Rutherford Rede financial planners.
For those who want to do it themselves, numerous calculators and software packages are available via the internet.
It's important first to understand your risk profile. This is something we as human beings often get wrong. It may be worth using a web-based test such as myrisktolerance.com to get a better understanding. Then it's a matter of choosing an asset allocation model to fit. The website sorted.org.nz has a very basic Investment Recommender test that advises the types of investments to consider, some investing tips and the level of liquidity you would need.
Some of the online calculators such as the one at CNNMoney.com are pretty basic, but will give financial planning-averse investors somewhere to start. It's possible to download Excel spreadsheets for asset allocation and portfolio rebalancing from the internet. Personal finance software such as Microsoft's Money Plus Premium or Quicken Personal Plus help investors monitor how their investments fit into their financial plan. At the sophisticated end of the scale are software packages such as Smartfolio.com.
These tools tend to be fairly international although each country has its own home biases. In New Zealand investors tend to be more heavily weighted in debt such as bonds than overseas our counterparts may be.
Asset allocation resources:
http://beginnersinvest.about.com/od/assetallocation1/Asset-Allocation-Resources.htm