Risk vs Return – What to do Next?

Yield investors beware! Are we talking bond yields or equity yields? How different are these two scenarios?

Reader feedback from the last two articles on investing principles seems to have hit a raw nerve. There is clearly a broad difference of opinions in where to be invested, whether portfolios should be split between bonds and equities and whether an active or passive strategy is best. This includes the big picture and the minutiae.

When it comes to your own personal investments, a thorough and honest analysis of your risk appetite and your time horizon for accessing liquidity is essential. Some will say that bonds are safer than equities. Within the equity space there are a number of options which will be evaluated as riskier than others. Perhaps some will consider large household names safer than smaller companies still climbing the success ladder. The point at which the risk changes from one category to another will always vary with opinions.

A majority of investors classify themselves as balanced. This is the middle of the road approach. At its lower end, there are safer areas than those found at the top of the range which could easily be classified as adventurous. So, even though you may be considered a balanced investor, you can be further fine-tuned toward one or the other extreme.

Your overall risk propensity will depend on the return you feel is sufficient to satisfy you, as well as how you feel about the safety of your investments and your appetite for short term market volatility.

With these factors in mind, what elements would make the overall portfolio right for you? Should a balanced portfolio consist of bonds and equities, or bonds, equities and cash, or even extend to have a property element included?

As an asset class, property is rather illiquid. Thus the general approach toward this area would be for the longer term.

If you are imminently retiring, you may need access to cash in a relatively short time frame. This means that you would need to keep some of your portfolio very liquid. This does not necessarily mean that property should be excluded. Its proportion will depend on the size of your total portfolio and timing of your liquidity needs. The use of real estate investment trusts (REITs), for instance, can produce steady income as well as provide all important liquidity.

Most balanced portfolios need to have a relatively long time horizon of three to five years. They need this time to realise gains from a typical investment cycle. .

There are a number of opinions about whether bonds or equities will be successful over the near term. Should this be a factor? In some ways yes but then again are you trying to time the market? In general watching an asset class and how it performs is a good idea. Equally if you are investing for yield and you buy bonds is it that important that you choose the best time to do this given that you are forfeiting income if you delay? In general, ‘timing the market’ is dangerous whereas ‘time in the market’ is regarded as a safer and lower risk strategy.

In the last month I have read two in depth opinions on bonds. One began with a statement that “yield buyers need to beware” and the other said “recent bearish trends are noteworthy but going against the crowd and investing in bonds now is a good idea”.

Both opinions discussed central bank rates and why they have been held at low levels. One opinion stated that governments are concerned that deflation will ensue if rates are increased but suggested that this is acceptable and economic growth could be maintained. The other was of the opinion that with low rates investors are seeking yields elsewhere and sometimes entering unwise leveraging where there is a danger of a house of cards scenario.

Equity markets have been fuelled to new highs and many are concerned that they will crash in the future. With increasing share prices, dividend yields are proportionally reducing. Some companies are thus not hitting targeted pay outs which in turn affects the yield rates of the equity class overall. Bond yield rates are therefore looking more attractive. Thus the proportion of bonds and equities in your portfolio needs to be carefully considered.

Are you suitably confused yet? Getting the balancing act right is not an easy task. There is no right or wrong combination; there are only consequences.

See me to discuss your overall situation and where you fit into the equation. I will offer you a free financial health check which may reveal a number of things that you will find useful in moving forward. No two people are the same so I will have a unique answer for you.

Questions to the author can be directed to PFS International on 02 653 1971 or email to enquiriesthailand@fsplatinum.com

Andrew Wood has been an expat in Asia for 35 years and is Executive Director with PFS International. He has been writing Net Worth articles for six years and has made a significant contribution to the PFS library of financial service articles dating back over nine years. These articles which cover the complete A-Z of financial planning are available to readers on request.

 

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