In my last article I suggested as an exercise that you work
out how much you hold in each of the three main asset categories,
namely cash, financial assets and fixed assets. Just to recap,
the categories comprise:
1) Cash – holdings in any currency in bank accounts,
term (up to one year) deposits, money under the mattress (!)
etc.
2) Financial assets – savings plans, pensions, mutual
funds (= unit trusts, managed funds), portfolios, insurance
policies with surrender values, shares, gold, collectible
items etc.
3) Fixed assets – land, property, private business etc.
Before reading on, convert these amounts into percentages
(eg. 30% cash, 30% financial assets, 40% fixed assets). Now
let’s see what the experts reckon to be desirable percentages.
How much should you hold in cash?
Asset allocation experts advise from 10% to 20%. For the higher
net worth investor 10% may be adequate as this will represent
a significant amount of cash. The smaller investor or someone
starting out to build up their assets is likely to need a
larger percentage. I always advise clients about to embark
on a long term savings or pension plan that they should hold
the equivalent of at least two years’ contributions
in cash as a reserve due to the importance of maintaining
a plan once started and the high cost of early surrender or
not maintaining contributions.
How much should you hold in financial assets?
Here the experts recommend from 60% to 80%. If this appears
high it is because financial (or medium term) assets can cover
such a wide range. With the exception of defined or contractual
pension plans, financial assets can normally be drawn down
or accessed at fairly short notice. Unlike cash however there
is a potential for short term losses if liquidated too soon
or at the wrong time. But over the course of time they can
be used to pay for one-off expenditures like school fees,
a new car or a deposit on a house or can be used to provide
a supplementary income in retirement. The different types
of financial asset, ranging from low-risk bonds to ‘blue
chip’ shares to gold to high risk emerging market funds,
can also produce different returns at different times. By
holding such a diverse basket of assets risk can be better
managed.
How much should you hold in fixed assets?
The experts suggest 10% to 20%. Now those who have invested
in land or property in Bali or elsewhere in the past five
years may disagree strongly and point to the significant rise
in land and property values over that period. But the experts
take a much longer view. People often forget how much a property
costs to maintain or how much it costs to run a business.
Winston Churchill commented that you cannot live off a stately
home. If you need cash in a hurry you cannot sell a bathroom.
A business is a fixed asset. Anyone who puts all his or her
savings and resources into a business is running a high risk
as there is nothing to fall back on if the business fails.
Leveraging, such as taking out a mortgage, is one way of keeping
fixed asset ownership within limits. Ideally, as your equity
increases as you pay off the loan your other assets should
be growing as well.
Are there exceptions to the recommended allocations?
There are bound to be. Someone starting out in life after
completing their education should be building up cash 100%
until he or she has accumulated enough to start medium to
long term investing or to put a deposit on a house. But the
young are sometimes tempted to spend as if there is no tomorrow
so an element of discipline or guidance by elders may be needed
to get them into the saving habit! I have known a number of
cases in Bali where people have cashed in all their medium
term savings plans to buy land or property. While potentially
risky, the logic of such a move is easy to understand, particularly
when land prices are rocketing. The chances are that the decision
will turn out to be a wise one (in terms of savings on rent
and the potential value of the property in years to come)
but the risk, particularly in terms of security of the investment
where foreigners are concerned, should be understood and an
effort should be made without delay to rebuild financial assets.
So how do your figures compare with the experts’ recommendations?
If you are in the range of 10-80-10 to 20-60-20 you have a
well-balanced allocation of assets. If you are outside the
range there may be good reason for it but the chances are
your financial health should improve over time if you are
able to do some rebalancing and get within the recommended
range.
This could entail buying a property if you don’t have
one or selling one if you have too many! Or it could entail
building up cash reserves or reducing them by investing. If
nothing else, this should give you food for thought!
Colin Bloodworth is a senior financial adviser with Financial
partners International. The opinions expressed are his own.
If you have any questions relating to personal finance you
may contact him at 021 520 8099 or colin.bloodworth@financial-partners.biz.
