LAST week, we defined Portfolio Allocation and got some interesting feedback. The point to note is that, many of us already have different asset classes in our investment portfolios, so we have inadvertently done some form of portfolio allocation. The question now is – does this allocation meet our investment objectives and cash flow needs?
To get optimum returns on investment, we must pay attention to the products mixing our investment portfolio. Our investment funds are channeled into three avenues: savings for emergencies, investments for life’s events (e.g. weddings or children’s education) and wealth-creating investments. Therefore, every investment portfolio must ensure that these three purposes are adequately catered for. The ideal investment mix includes liquid (that is, easily converted to cash) and not-so-liquid products. The ratio of liquid to illiquid products depends on purpose and tenure of investment. Savings for emergencies because of its short-term nature should be in cash and near-cash products from the money market. A children’s education product has a longer term because it is usually targeted at tertiary education. The education product manager would invest the funds in a combination of money and stock market products. When we invest for wealth creation and retirement, which are long-term, we could buy real estate, private equity and insurance annuities.
Tenure of investment is critical to the choice of product, whilst the age of the investor influences tenure. Therefore, age is critical to portfolio allocation. A person who is already in retirement is now totally reliant on his investments as his main source of income. Such a person’s portfolio should have more products that can easily be converted to cash and fresh investments in real estate (for build to rent purposes) may not deliver sufficient return on investment in the investor’s lifetime. Meanwhile, a 30 year-old who still has a regular salary from employment/ business could invest more on illiquid assets. Savings for wedding and emergencies would form the liquid part of the young woman’s portfolio.
Another factor to consider in portfolio allocation is the individual’s attitude to the risk profile attached to each class of assets. Money market and real estate are usually low risk. Stock market products have higher risk because they carry the potential that the investor can lose his principal in the short run; but if the investments are made in properly managed companies with robust customer bases, the investments would appreciate in the long run. Higher risks investments generally have higher returns than lower risks alternatives. Therefore, we should diversify our portfolios and allocate investments to different investment classes and balance out the risk-return tradeoff.
From the above we learn two things; firstly, there is no ideal portfolio allocation that fits everybody because the allocation is dependent on very subjective criteria. However, every individual has his own ideal portfolio based on his peculiar circumstances and we need to arrange our portfolio in line with this ideal so that we can earn optimum returns on our investments. Secondly, portfolio allocation is dynamic. As our circumstances change, we need to adapt our investments accordingly.
Products to consider in the investment mix are money market products (T-bills, FGN savings bonds, government and corporate bonds, commercial papers and fixed deposits), stock market products (company equity shares and mutual funds), trust products (voluntary retirement savings accounts, education trusts, unit trusts, real estate trusts, investment trusts etc.), insurance annuities (life/term insurance, retirement plans, education plans, etc.), private equity (including crowd funded businesses) and real estate. Of course, we can also start businesses that we run ourselves; but those are not sources of passive income because they require our time and attention. Whatever investment mix we choose should fit our peculiar circumstances and be adaptable to changes in our circumstances.
Before making any investment, we must do our due diligence comprehensively. Please seek professional advice from bankers, stockbrokers or real estate professionals but also ensure you are personally convinced about any product before investing. When professionals get paid commissions from the products they sell to you, their advice may not always be in your best interest. So, seek advice from two or more professionals then go online to investigate the product you want to invest in. Our investigations should also cover the ethics and integrity of the underlying investment/ manager of the product – do they conform to your own moral values?
If we carefully follow these guidelines, we should have the right product mix in our portfolios, develop multiple streams of income and position ourselves to earn optimal returns on our investments. Happy investing.