As financial planners our first concern is to ensure a client
has sufficient cash for the short term, adequate protection
in place for self and family and then we can look at building
up wealth through traditional financial assets. While doing
so we give high priority to capital protection. The psychologists
tell us that people are more upset at losses than they are
excited by gains. I can vouch for that as I recall the unpopularity
of the financial services industry during the long bear market
of 2000 to 2003! As a result of the bitter experience of investors
around the globe forward-thinking planners have now adopted
modern portfolio theory which was actually developed by an
economist called Markowitz decades ago. Unfortunately, no-one
listened to him at the time because they were making so much
money in the stock markets. Now the investment world has sat
up; portfolios no longer consist of just the same old stocks
and bonds.
So where do wise investors place their money now?
Property of course has become a favourite asset in recent
years. This has now become a disproportionate part of many
people’s total assets. So where does the rest of the
money go? Apart from cash in the bank (which barely keeps
pace with inflation) and the traditional stocks and bonds,
two new classes have come very much to the forefront in recent
years. They are hedge funds and commercial property funds.
The point about both of these asset classes is that their
performance is not closely correlated with stocks and bonds.
This reduces the likelihood of all one’s investments
falling sharply at the same time. In other words, volatility
is reduced although overall performance over the long term
is sustained. What is critical however is the percentage allocation
to each asset class. This is where the experts come in since
asset allocation accounts for more than 90% of the volatility
in portfolio performance over time.
But what about people who want a higher return?
Firstly I would not advise anyone to go into a higher risk
investment unless they already have substantial holdings in
traditional, less volatile investments. But for those who
are well on the road to financial independence (a state where
one’s investments are sufficient to generate enough
income that it is no longer necessary to work) there are opportunities
for higher than normal returns. Even those who are a long
way from financial independence may indulge a little in more
exciting investments but these should represent just up to
10% of one’s total assets, or up to 20% as an absolute
maximum. For the very rich there is no limit, but even they
would be wise to keep a core part of their total wealth in
safe havens. Whatever the percentage, the investor must be
prepared to see a potential loss of a large portion of that
amount in the worst case scenario. There is no gain without
pain!
Accepting the risk, where are the higher returns?
In Bali you could include buying land or property, opening
a bar or restaurant or setting up any kind of business. The
risks apply anywhere in the world but as a foreigner the risks
are much higher. Going into business can be very rewarding
but in general, for every business that succeeds at least
four go to the wall. If you like property but not the hassle
of buying and selling there are options such as land banking,
buying shares in new projects or just buying units in a commercial
property fund. These are now to be found in the basic portfolios
already described but a higher net worth investor may wish
to have a larger share. Many such funds made over 20% last
year. One particular commercial property fund made over 40%
last year and close to 200% over five years.
Where is money to be made apart from business or property?
There are plenty of opportunities! For example, the well-heeled
investor can diversify into assets such as gold and precious
metals. You can buy the physical commodity of course, but
that is not always wise or practical. It is now possible to
buy them indirectly via managed funds. Alternatively you can
invest in a mining fund. This will tend to be more volatile
as the movement of the share price will be greater than the
movement of the price of the commodity. Many other commodities
are available via managed funds. A sizeable percentage of
a balanced portfolio will consist of hedge funds. These tend
to be fairly conservative with low overall volatility. More
aggressive hedge funds however are available to the wealthier
investor seeking higher returns. In some cases the higher
returns can be obtained by ‘leveraging’ which
means borrowing to buy more shares, not dissimilar to taking
out a mortgage on a property. Consequently any gains are magnified.
But so are the potential losses!
Private equity / Venture capital
For the ‘mass’ wealthy who want to achieve high
returns without being personally involved as with property
purchase or setting up a business there are now more and more
opportunities to invest in venture capital / private equity
projects. Like hedge funds twenty years ago private equity
used to be the domain of the ultra rich. Today it is possible
to get into venture capital / private equity at a much lower
threshold. This could entail providing ‘seed’
money for a new business or project. If the venture succeeds
the returns can be very high. But if it fails, you could face
heavy losses.
At the end of the day, there is no easy, risk-free way to
obtain high returns. If you are ever offered a product that
guarantees high returns without strings or conditions, beware!
There is always a downside. High returns are certainly achievable
as you can see from some of the examples quoted, but at the
cost of higher risk. Risk and return are directly related.
Having said that, if you have been following good investment
principles and have built up a solid and diverse portfolio
then there is no harm in having a little fun with a strictly
limited part of your assets. After all, where would a chicken
curry be without spices? But don’t go overboard with
the spices or leave the chicken out of the equation!
Colin Bloodworth is a senior financial adviser with Financial
Partners International. The views expressed are his own. If
you have any questions you may contact him at 021 520 8099
or colin.bloodworth@financial-partners.biz
