Bruce Brammall, The Australian, 7 January, 2024
“What should I invest in to get the best returns?”
Financial advisers get this question a fair bit. And it can be a frustrating one, depending on the frame of mind of the person asking the question.
As with more broadly in life, some people ask experts questions and keenly listen to the answers. Others ask, but scoff unless the answer reinforced what they were already thinking.
In any case, here is the answer to the question. The best returns come from taking the biggest risks.
If you’re just as happy to lose almost your entire investment, possibly many times over, as to potentially see it quickly double, triple or do a 10-bagger, then there are investments that will be well suited to you.
You can bang money into crypto, IPOs, options, futures, contracts for difference, penny stocks, precious metals or junk and high-yield bonds.
Frankly, and pardon my French, but that’s not the sort of shit I recommend.
Most people have no interest in taking that sort of risk with their hard-earned savings.
If that “all in” investment approach sums you up, the internet has plenty of “next big thing” theories for you to wade through. Good luck. And I’m sure you’ll be be able to use your superior intellect to avoid the obvious pure scams.
For everyone else, I have some more sensible advice. Let’s talk about how to build your own portfolio.
The first things to know about building your portfolio is understanding your time frame and then your risk appetite.
Today, we’ll be talking about building portfolios for longer time periods. That is, generally seven years or longer, such as your superannuation or other money you’re using purely to build for the future.
If you need your money back in a few years (for example, it’s your deposit on a home), then stick to cash and grab the best interest rate you can get.
Then you need to know how much risk you are prepared to take – your risk appetite. There are plenty of risk profiling tools available online. What they are trying to help you do is to find out whether you are a conservative, balanced or aggressive investor, or somewhere in between two of those three.
This will help you determine how much money you should have in each of the asset classes – cash, fixed interest, property and shares.
Are you going direct shares, exchange-traded funds (ETFs), or managed funds, or a combination? Are you trying to truly build a diversified portfolio, or are you going for one pre-fabricated diversified investment?
The approach here will partially be determined by size. Are you starting small and building it up slowly? Small, but building it up quickly? Or starting with a larger amount – say $150k or $200k – and continuing to build from there? Or do you already have half a million or a million or more?
Why is size important?
Because if you are starting small and adding small amounts, then the trading costs of buying shares and ETFs will be comparatively expensive. A multi-sector managed fund or ETF might be a better option to give you instant diversification across asset classes and domestic and international options.
There are plenty of index-fund based options here that deliver global asset diversification with low ongoing fees. And, for anyone starting out, or starting small and wanting to add on a regular basis, it’s hard to go past Vanguard’s diversified portfolios.
If you’re starting small but can build it quickly, or already have a sizeable sum, then the options are broader, as you develop your portfolio over time.
If you’re looking to purchase a few assets to have instant diversification, then there are a few ways to build your portfolio, at relatively low cost.
Providers such as Vanguard, Betashares and Blackrock’s iShares, have options that will allow you to purchase individual asset classes with instant diversification and usually at an extremely low ongoing management fee.
For example, Vanguard’s Australian shares ETF (the top 300 stocks in Australia) has an ongoing management fee of 0.07 per cent, while Betashares’ cost is 0.04 per cent (covering the top 200 stocks).
This gives you an index weighting to the top listed shares, so you’ll have a bit of everything, but more of the bigger shares, such as BHP, CBA and CSL. I’ll come back to picking direct stocks shortly.
But too many people think owning Australian shares is how you build a portfolio. Ignoring international shares is dangerous, from a diversification and returns perspective.
Let’s take calendar years 2022 and 2023 as an example. In 2022, Australian shares massively outperformed, even though they had a total return of about -2 per cent, as international shares did -18 per cent. In 2023, Australian shares did a good job at roughly 14 per cent, but international shares did about 25 per cent.
International shares are easily purchased via ETFs and managed funds, also with low-cost ongoing fees, when using index style funds.
The advantage of making international investments via index-based ETFs and managed funds is that you will pick up some of those sectors that are not well covered in Australia, such as the big US tech stocks, including Meta, Google, Tesla, Apple, Microsoft and Amazon.
Core and satellite
You want to bet on individual sectors, or individual companies? Be aware that it can be dangerous if you put too much of your nest egg in high-risk stocks.
A better way of doing it would be to consider what the financial advice industry refers to as a “core and satellite” approach to investing.
That is, have the majority of your investments (the core) sitting in broad-focus investments, but then run some satellite investments with smaller portions of your funds.
How much? I’m a believer in index funds capturing a broad range of the economy, so in my opinion, a low amount, perhaps 5-10 per cent of your investments. Others might say as much as 15 or 20 per cent.
There are hundreds of ETF and managed fund options to wade through. If there’s a sector with enough interest in it to be considered a “theme”, then there will generally be an investment option available that will give you more diversification than trying to pick individual companies.
Be aware, often theme funds often appear as a sector has had considerable growth … and often just before a correction is coming. Do some serious homework. Or avoid.
Done properly, core and satellite allows you to have the majority of your investments picking up the returns of the various markets, while still supporting some smaller industries.
Property and bonds
Property and fixed interest (also referred to as bonds) will generally make up a much lower portion of your investments, but the same rules apply as to what we’ve already gone through.
With property, there are ETF and managed fund options for both Australian and international property, plus some themed options.
When it comes to bonds, the more defensive an investor you are, the more bonds you should generally have in your portfolio. But there are investments for both Australian and international, government and corporate debt.
Australians love to build their own Australian share portfolio. Some do that very well, but many fill their portfolio with “next big thing” stocks, based on a mate’s recommendation or something they read.
I’ve seen that become a disaster more times than I can count.
If you’re building a long-term portfolio and starting with a reasonable initial sum, then building a base of quality Australian stocks, focussing on the top 20 or 30 stocks, can also be a good “core” approach. Again, if you want to pick a few themes, or play with a few small companies, then that would fill out your “satellite” option.
While index funds can be broadly “set and forget” because they are constantly internally adjusting their holdings, direct share portfolios need regular monitoring and adjustment.
The old saying that blue chip shares can be put in the bottom drawer and never looked at again is an old-world fallacy. They need to be reviewed. Regularly.
And, in any case, if you’ve got dividends and distributions coming in from your various investments, their review should become part of your ongoing strategy.
Lacking sex appeal?
The above might not sound sexy. And I might have made it sound a little complex. I’ll make no apologies for that.
As I started out, investing is a long-term game. Your main options are to do it yourself and put aside the time to work on it regularly, or you hand all of it, or parts of it, over to investment professionals to manage for you.
But don’t sit there waiting for a sign from the investment gods. Get moving.