We have already discussed investing in bonds, commercial property, residential property and shares. We will now draw it all together into an investment strategy for all seasons.
The key issue
Study after study indicates that virtually no one - not even the experts, fund managers or sharebrokers - can successfully and consistently forecast economic events, interest rates, exchange rates, or pick the right bonds, properties, or shares/stocks, year in and year out.
It therefore follows that no one can pick the best investment class to be in right now. In my opinion there is no such thing as a single best investment.For most of us, a diversified portfolio is probably the top solution.
High-quality bonds form the foundation of an investment portfolio, since they are low risk and can be bought and sold at any time. Diversification over 100-plus bonds is easily achieved by using the DFA bond funds offshore and perhaps some of the AMP bond funds onshore. For the most part they pay income of about 1 to 2 per cent better than the bank, too. But there is no growth, values can fall if interest rates rise sharply. Right now they are very expensive and it is hard to get a decent yield.
Easy to do via listed property shares. It is possible to get quite a good yield of 3 to 4 per cent more than a bank, and diversification is quite easy to achieve, as each of the funds we discussed holds 50 or more properties. They are liquid, too, because they are listed on the sharemarket.
However, they are all in New Zealand - a very small country with a narrow economy, and their share prices are pulled up and down with the sharemarket as a whole. In an economic downturn, they can lose the odd tenant and have vacant space, so the rent/yield can fall.
The yield on most rental properties in reasonably buoyant towns in New Zealand is about 3 per cent. Additional return has to come from capital gain, but you cannot spend the capital gain (if you need income) until you sell the house.
You can get yields as high as 8 to 10 per cent if you buy a house in a very depressed town and rely on the rent being underwritten by Work and Income. There is unlikely to be much (if any) capital gain, and this kind of investment is not everybody's cup of tea either.
Residential property investment is probably more suitable for younger people who do not need income and are seeking long-term capital gains. It is perhaps less suitable for those who are nearing retirement, or are retired, and need a good income stream.
Tenants can be a problem (possible damage or rent arrears) and tenants are perhaps over-protected by the law. Diversification is hard to get, and liquidity is an issue, too - you just cannot get money out of a house quickly.
In good times, the returns from shares can easily exceed the returns from bonds and property. It is easy to get diversified, by using the NZX50 onshore which holds 50 NZ shares, and various funds offshore, such as DFA, holding up to 5000 shares.
Provided you are diversified, liquidity is not usually a problem - shares can be sold and you can get your hands on cash within seven to 14 days.
But the weakness of shares is fourfold. They do go up and down, all too often they are much misunderstood and too many people try to forecast and stock-pick, which rarely works.
Last but not least, human nature gets in the way, with too many investors buying in when things are good or shares are expensive (driven by greed), and selling out when things look bad (driven by fear), and selling out at low prices.
When investing in shares:
- Buy in when things don't look so good, and/or average.
- You must be disciplined and be prepared to wait.
Younger people who do not need income and are seeking longer term growth should have about 70 per cent shares, 10 per cent property and 20 per cent in bonds.
People near retirement, or retired, who need income, should have about 65 per cent bonds, 10 per cent property and 25 per cent in shares.
People who have about eight to 12 years until retirement should be balanced at 45/10/45.
The global financial crisis of 2008 and 2009 was a major test of investment funds. The DFA bond funds continued throughout the crisis without a blip, averaging over 7 per cent per annum.
All share funds including DFA went down, but the DFA share funds have been rising again quite nicely since March 2009. At no point were any of the DFA share funds impaired or frozen in any way - they remained liquid throughout.
By using a diversified portfolio of these funds, your risk is not the risk of a fund failure or total loss - rather it is the volatility from rising and falling share markets, but remember (historically at least) shares have a lot more ups than downs.