Choose a Broad Based Equity Portfolio

There is nothing right about accumulating savings in defensive or conservative KiwiSaver accounts or investment products, if the objective is to maximise the growth of the fund because the investor wishes to retire and live off the proceeds.

Advisers and institutions that promote such a practice are like parents who believe their teenagers can make appropriate life decisions.  Boundaries and consequences being ignored.  People do not accumulate into defensive and conservative asset allocations because they know what they are doing.  They do so because they fear loss and misunderstand volatility.  Financial advisers, financial institutions and financial regulators have been obsessed with risk assessment checklists for decades.  Again, that’s like asking your 16 year old daughter if she would prefer a chaperone on her night out.   Whilst we know the answer we also know her trust in human nature will be somewhat naïve.  What we attempt to do is educate her in advance, promote morality, choice and consequence.

But that’s not what’s happening with savings and investment.  The cop out is the risk assessment question or even worse – ‘Which fund would you prefer’  ‘Here are your options’ ‘The more conservative, the less risk’.  The analogy now is allowing our teenager to select the next date via the internet.  Let her choose and trust in the information presented. ‘Young professional male, living at home looking for friendship and fun with a young woman for companionship’

Most young women have this stuff sorted not long into puberty because Mum understands life.  But not many Mums understand the stock market.  Even the most fundamental of question, like – what is the stock market would embarrass and create discomfort.

Risk assessment questionnaires don’t ask this question.  Bank clerks do not ask this question, yet 94% of fund performance is determined by asset allocation and asset allocation is being chosen through misrepresentation.  The cop out is to put the selection into the hands of the investor.  ‘The teenager’ Sometime later, usually too late.  ‘I wish I knew then what I know now’.

The travesty is that the educators are perceived as the poachers and the gamekeepers perceived as the good guys.  No different to Mum attempting to give daughter the drill about deportment, desire and dialogue.  They eventually become friends again with some years of anxiety and stress preceding the reunited family.

The problem with saving and investing in inappropriate funds is that it’s often too late to capture lost returns when the penny drops.  The original product sale was made because it was easier to sell someone what they thought they wanted than to educate and advise.  Fear of the future is a huge handicap to most investors – whether accumulators or lump sum.  The problem is, we fear the wrong things – just like our teenage daughter.  Fear is often so strong it magnifies the real risks.  For example, the real risk in retirement is running out of lifestyle. This can happen from  A) not having enough money at retirement with which to fund a thirty year lifestyle  B) losing purchasing power (being invested in funds which don’t maintain a return above the cost of living – inflation)

People fear loss of capital.  They equate volatility with loss and the word ‘risk’ with meaning loss.  Therefore when completing a ‘risk assessment questionnaire’ the immediate connotation being: this is an adviser absolving responsibility’ (correct) or  ‘I don’t understand this stuff – I’ll take the conservative route ‘or I’ll use the bank they don’t even ask me this stuff!

After 40 years of giving financial advice – none of my clients felt relaxed through the global financial crisis because they were compelled to complete a risk assessment questionnaire at the time they invested – prior to the crisis or through the resultant recession.  What got them through was the mutual trust and respect for rationality under uncertainty – provided by calm and ongoing communication.  Try getting that from a bank.

Since 1926 the average time from a major market top through the subsequent bear market and back to full recovery (with dividends reinvested, and adjusted for inflation) is about 40 months.

Finally, it would be unwise for an average retiring couple to believe they will live “only” the average thirty-year retirement.  Assuming that we must that they will live even longer, its incumbent on us to help them plan to fight off even more long term erosion of purchasing power (at an average of 3% annual inflation living costs rise by about  2 ½ times over thirty years)

Holding broad-based equity portfolios is the most reliable (if not the only) means of doing this that we know.  It is how we help people vanquish the real risk of retirement, which is outliving one’s money.

If I’m promoting a broad based equity portfolio at age 65 (because my average client couple will live 30+ years) it stands to reason that I’d also propose a broad based equity portfolio for the accumulation 30 years – prior to retirement.  You’d be correct – and even more so over the next few years because I think under most scenarios it is unlikely that global bonds can fulfil their traditional performance offset to growth assets in a balanced portfolio in any meaningful way.