THE FOUNDATION OF A RESILIENT INVESTMENT PORTFOLIO
Cam Watson, 21 August 2017
As any builder will tell you, the most important part of a house is the foundation. Get that wrong and the house will never be quite right. Walls won’t be plumb, it may even look slightly askew, but most importantly, an unsound foundation could weaken the house and mean it is unsafe to live in.
Investment portfolios are exactly the same. Having a flawed foundation can undermine its resilience and mean it never delivers the income or growth an investor needs it to. The foundation of a portfolio isn’t piles or a concrete pad, it is something much less tangible, but no less important – diversification.
There is a never-ending debate in New Zealand around the merits of individual investments; property versus shares or shares versus cash deposits and so on.
‘This talkfest misses the point. The best investment for long-term investors is not property or shares or cash singularly but a combination of them all. We call this a balanced portfolio.
There continues to be a resistance in New Zealand to balanced portfolios. Perhaps this is drawn from our historical experiences with investments. Property on its own has done very well over recent decades, while many who experienced the 1987 share market crash still have a deep aversion to shares and prefer cash deposits, which have long been seen as a safe alternative.
Investment advisers see themselves as risk managers. As such, one of the most important ‘value-adds’ they provide clients is to put together a portfolio which is prudently diversified, not only across different assets, but also within each market. This helps to mitigate risk while positioning clients to share in the potentially higher returns growth assets like property and shares can provide.
The past decade has shown how important this is. In June 2008, based on Reserve Bank data, six-month deposit rates were 8.4 percent. Many retirees with their savings in deposits will have understandably done their sums on living costs expecting interest rates to stay around this level.
Cue the 2008 financial crisis, and by June 2010 deposit rates were sitting at 4.7 percent. Worse, these rates haven’t rebounded. In fact, they have fallen further. The June 2017 data shows the six-month deposit rate sits at just 3.31 percent. This has had a devastating impact on people who were relying only on deposits to fund their retirement.
While rates have stayed low, New Zealand shares have boomed. Since the dark days of June 2010, our market has returned 14.4 percent a year. Few would have thought in 2010, as markets were still regaining their footing after the global financial crisis, that we would see our market more than double by June 2017.
That is the point. Nothing is predictable in markets. None of us know what markets are going to deliver in future, good or bad. The best form of protection for those who are serious about protecting their financial wellbeing over the long term is to build a portfolio with a solid foundation, and the strongest concrete available to investors is diversification.