By Ciara Conway, Stake
While the days of the 60/40 stocks to bonds portfolio may seem dated, the stock market’s roaring decade of dominance has slowed abruptly for now. Portfolios with an investment strategy weighted heavily towards exposure to tech and other growth stocks may have enjoyed a period in the sun but the past year hasn’t been so kind. A diversified portfolio is proving its importance now more than ever.
SMSFs provide a clear path to the diversification of your super
Diversification is the allocation of a portfolio across multiple asset classes and multiple different assets within each class. For example, owning a mix of tech stocks and bank stocks within a share portfolio but also exchange traded funds and government bonds as well.
Diversification smooths the natural ups and downs of markets. For example, if the stock market dips, a portfolio diversified across real estate, fixed income (bonds) and cash will have a less extreme fall than a concentrated stock portfolio. Moreover, a diversified portfolio provides exposure to the market’s ups as well.
With a self-managed super fund, members have the flexibility to invest in (and diversify across) so many more asset classes than just stocks and bonds. Exchange traded funds, real estate, managed funds, start-ups and really any alternative asset class can sit beside the likes of major index funds and treasuries in the modern super portfolio.
Types of portfolios
In broad terms, we can bucket portfolios under one of three labels: growth, balanced and conservative:
Growth portfolios have their asset allocation weighted towards those with higher potential returns, typically allocating 70-80% of the portfolio to high growth assets. These assets often include shares, infrastructure, private equity and to a lesser extent other alternative assets.
A growth portfolio is used for an SMSF investment strategy aimed at providing higher long-term returns with the potential of short-term volatility meaning these portfolios can see significant growth in good years but have the potential for significant losses in bad years.
Generally, younger SMSF investors with a longer investing time horizon, higher risk appetite and lower sensitivity to short-term volatility will gear their portfolios towards growth assets.
The tried and tested approach, a balanced portfolio has a relatively even mix (approx. 60/40) of growth and defensive assets in order to provide both income and capital appreciation while reducing some volatility. For example, income can be delivered from bond coupons, dividend payments and cash interest on the defensive side and moderate capital gains from property and more stable large-cap stocks on the growth side.
Typically an investor with a medium investing time horizon willing to tolerate some short-term volatility alongside moderate long-term growth will seek a balanced portfolio. A balanced portfolio is often used for an investment strategy looking for growth alongside a need to protect previous gains – often as members reach the second half of their working careers.
Conservative portfolios are those with the most limited exposure to growth assets. Generally, at least 70% of the portfolio will be allocated to defensive assets like index funds or bonds as well as a significant allocation to cash. The most obvious benefit is capital preservation. In a market downturn, losses are smoothed out even if the longer-term upside is capped.
The goal of a defensive investment strategy is just as much about lower volatility as it is to maintain achieved capital growth.
Generally speaking, as SMSF members move towards their targeted retirement age or balance, the portfolio will move towards a more conservative balance.
The role of cash
The allocation of cash within a portfolio will vary as a result of the investment strategy and resulting portfolio structure.
Given its liquidity and minimal volatility, typically conservative portfolios will have higher allocations of cash to ensure the fund’s strength against market fluctuations as well as its ability to have its value tangibly realised and accessed as necessary. Growth portfolios will often have lower allocations of cash due to typically low capital growth and mitigate against devaluing in low interest rate environments.
The above isn’t set in stone, particularly during periods of market volatility or high inflation like the one we are currently in. During this time, cash is often used as a hedge across a range of portfolio structures provided short-term interest rates are mirroring the rise in inflation.
Ethical investing, or ESG investing, is a strategy that considers sustainability (environmental, social and governance) alongside financial factors to inform their investment strategy.
Ethical considerations can range from a minor factor influencing a portfolio’s structure through to the mandate that all investments need to fall under irrespective of whether the portfolio is growth, balanced or conservatively structured.
Don’t be afraid to rebalance
SMSF portfolios aren’t, and shouldn’t, be set in stone. Each year fund trustees are required to review their fund’s investment strategy annually to ensure it is best serving the needs of its members.
Like the markets, an SMSF investment strategy and resulting portfolio structure can be dynamic to best leverage investment opportunities and lessen investment risk. For example, a portfolio in the growth phase may be restructured to be more defensive during a market downturn or period of increased volatility. While a conservative portfolio may up weight some growth stocks looking to capitalise on a period of well sustained economic performance.
The key element is to ensure that a clear strategy is set and monitored to determine if further adjustments should be made.
Choose the right portfolio
There is no such thing as a definitively ‘right’ portfolio. An SMSFs investing strategy and resulting portfolio structure will vary greatly based on the ambition, risk appetite and needs of its members. Being clear on those three elements is critically important and understanding what role diversification can play will provide members with a key tool to reduce risks and provide sustainable portfolio growth.
Disclaimer: This does not constitute financial advice nor is it a recommendation that an SMSF may be suitable for you. As always, do your own research and consider speaking to a licensed financial adviser before making a financial decision. This article has not taken into account your personal circumstances, financial objectives or needs.