If you’ve read the my article about why we prefer to use managed funds you’re probably wondering what our portfolio looks like, so here it is:
Just a note before I start explaining how we arrived at this particular asset allocation: this article is intended to show you what we have done once we considered our individual goals and risk tolerance. Your circumstances are going to be different so you will need to consider your own situation when constructing your own portfolio.
The basis for our asset allocation is as follows:
100% growth assets
There is no allocation to bonds or cash in our portfolio as we have some years to go before we will need to draw on these funds. This means that we are in a position to ride out short term market volatility with a high exposure ourselves to the risks of equities and property with the expectation of higher long term returns.
Equities outperform in the long run
In the long run, Australian equities have outperformed property (Boreham 2019). The same can be said about US and International stocks when compared to bonds – an excellent chart produced by the Center for Research in Security Prices is available here. For us, choosing this asset class to be the bulk of our portfolio makes sense because in the long run shares are driven by companies’ profit growth. And who is at the helm of these listed companies? Some of the smartest, most hardworking people the world has to offer all devoted towards providing strong shareholder returns. When put like that equities just makes sense.
Property asset class diversification
Even though I love equities I also acknowledge that we require a certain level of asset class diversification and we do that by holding about 7% of our portfolio in an international property fund. We prefer this method of exposure to the property asset class because it’s more diversified; less work; has lower transaction costs, more liquid and lower ongoing expenses than a direct investment in property. Like shares we acknowledge that we are unlikely to outperform the market in the long run by choosing properties ourselves. Also we can invest in property funds without leverage which allows us to adequately control risk.
Australia is only 2% of the world market
Even though the Australian stock market accounts for just over 2% of the world market Australian investor portfolios contain and average of 66% Australian shares (Bowerman 2017). This is known as home-bias investing. The problem with this is that it reduces diversification and increases risk to the individual investor. By investing across the globe we are reducing our downside risk if Australia ends experiencing low growth over a particular period. This is why more than half over 60% of our portfolio is invested internationally.
Currency risk
Being invested internationally means an inevitable exposure to currency risk. The growth of our funds moves inversely to the currency price movements so if the Australian dollar strengthens then our returns will fall. Having said that, if the fund value improves and the Australian dollar weakens then the returns will be even higher. Since we acknowledge that we can’t predict currency price movements we’ve opted for a 50/50 split between hedged and unhedged international funds.
Improving tax efficiency
As of July this year we stopped allocating new funds towards our property fund due to the large distributions that it provides (Vanguard 2019). Since both of us are currently still working we decided to make this change in order improve the tax efficiency of our portfolio returns. As of 2019 our international and Australian equities funds already consist of 7.36% (Dimensional 2019) and 3.25% REIT’s (Dimensional 2019) which takes care of the diversification into the property sector. So in time we will expect to see the property asset allocation decrease relative to the other asset classes.
Re-balancing
When we need to re-balance our portfolio we do so by diverting a larger proportion of new money into the new funds that have seen lagging performance. Doing it this way, as opposed to selling overweight funds and putting the proceeds towards the underweight funds helps us to reduce capital gains taxation as well as transaction costs.
So there you have it, our portfolio allocation and basis for investment. So how is you portfolio constructed?
Engineer your freedom
References
Bowerman, R 2017, Why investors fall into a home-bias trap, Vanguard Investments, viewed 27/9/2019, <https://www.vanguardinvestments.com.au/retail/ret/articles/insights/research-commentary/portfolio-construction/home-bias-trap.jsp>
Boreham, T, 2019, Property vs shares? The long-term verdict, Westpac, viewed 27/9/2019, <https://www.westpac.com.au/news/money-matters/2019/04/property-vs-shares-the-long-term-verdict/>
Vanguard Investments, 2019, Vanguard International Property Securities Index Fund, viewed 27/9/2019, <https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/wholesale/portId=8115/?prices>
Dimensional, 2019, Australian Core Equity Trust, viewed 23/9/2019, <https://au.dimensional.com/funds/australian-core-equity-trust>
Dimensional , 2019, Global Core Equity Trust, viewed 23/9/2019, <https://au.dimensional.com/funds/global-core-equity-trust-aud-hedged-class>