When it comes to investing, diversification and an active versus passive approach are two heavily debated areas that the average investor often struggles with in their portfolio.
It is important when constructing an investment portfolio to acknowledge the limitations on predicting future market outcomes. We just don’t know with certainty where markets will be in twelve months’ time or what disruptions lurk around the corner. What we can do is prepare for different scenarios by constructing a portfolio which is responsive to various outcomes.
Investment Rule #1 – Diversification
A good motto to follow is “prepare not predict”. Firstly, diversification helps to prepare for different market outcomes. For example, for the year to March 2015, Australian equities returned 13.90% and international equities returned 29.12% in Australian dollars. The difference in return had very little to do with equities and everything to do with currency. Increased exposure to international equities in a portfolio over that time was to reflect a weakening Australian dollar since the beginning of 2014. Diversification of equities away from the domestic market was a critical portfolio design element that produced strong results at that time.
The other argument in favour of diversification is risk and reward. We always say that you can earn more than you currently are from your portfolio, you just need to take more of the right sort of risk. The returns will probably come if you are patient enough, but they may not come at the time of your choosing. What is less ideal is risk that you don’t get paid for (in terms of better portfolio returns). One of the great benefits of diversification is that you can often maintain returns whilst dramatically reducing risk in your portfolio, and that is a win-win.
Investment Rule #2 – Active vs. Passive Investing
The second investment theme is active versus passive investing. Passive managers invest their funds in line with an index – for example, passive Australian share managers will build a portfolio of shares which mirror the ASX 200 or ASX 300. Active managers will build a portfolio based on a theme and hold a smaller number of shares and trade them more often.
The often quoted view is that passive managers outperform over the long-term because the majority of active managers don’t consistently beat the index. However, well run active managers can consistently outperform the index. We follow the art of portfolio construction, which identifies and engages those funds. We only need to find 10 to 15 good funds out of hundreds to make a difference.
Manager selection should be done by researching those who have sound and repeatable investment, risk management and portfolio construction processes. This can be demonstrated by consistent out-performance against benchmark (net of fees) within tolerable risk limits. These should be included in your portfolio. On other occasions, you may not find one that fits your criteria and an index option may be better. The key is being open-minded and allowing yourself to enjoy the additional benefits of active investing. We always remember that with passive investing, we are investing in the whole market, even the stocks I don’t like! The key to success with active investing is research.
Diversify and research your active investment options and enjoy the potential for better returns in your portfolio with lower risk.
At Blueprint Wealth, we offer financial advice that is right for you, no matter what stage of life you are at. Contact us to set up a plan that is right for you.
*Greg Major is an Authorised Representative of AMP Financial Planning Pty Ltd, ABN 89 051 208 327, AFS Licence No. 232706.
Blueprint Planning Pty Ltd (ABN 78 097 264 554), trading as Blueprint Wealth, is an Authorised Representative and Credit Representative of AMP Financial Planning Pty Ltd, Australian Financial Services Licensee and Australian Credit Licensee.
This article contains information that is general in nature and does not take into account your objectives, financial situation or needs. Therefore, before making any decision, you should consider the appropriateness of the advice in regards to those matters.