Step 1: Understand your risk profile
ANZ Financial Adviser, Zoe Morris, says the first thing novice investors have to understand is their risk profile.
“Some people can put a lot of their money in high risk, high return speculative investments and still sleep well at night and some can’t,” Morris says. “There are quick online quizzes that will provide a rough idea of how comfortable you are with risk. But I prefer to sit down with new clients and get a deep understanding of their personal circumstances and personality to determine what asset classes are likely to be the best fit for them.”
Morris, who remembers the GFC, says investors need to ask themselves the hard questions before investing in any asset class.
“Investing can be fun when everything is going well, but people need to be honest with themselves about how they’ll cope if they suffer a market downturn” she says.
Given market volatility is a fact of life, even when American housing markets aren’t collapsing and global pandemics aren’t raging, the first step to creating an investment strategy is deciding how much risk you can tolerate.
“If you keep your money in a fixed-interest savings account or buy bonds, you get a predictable return,” Morris observes. “But even then, the inflation rate will affect the real return you’re making. If you invest in real estate, shares, gold or cryptocurrency for any length of time, you can expect to see prices rise and fall, sometimes dramatically. If you’re a conservative investor who is uncomfortable with significant price fluctuations, you should think twice about investing heavily in those types of asset classes.”
Weighting your portfolio in turbulent times
Investing always involves risk-return trade-offs. But both the risks and potential returns tend to increase during periods of economic disruption.
Interest rates have been low since the GFC and are now barely above zero. That means there’s little incentive to leave lots of money parked in cash. However, as Morris points out, having ready access to cash can be useful. “If, for example, property prices suddenly head south you may be able to snap up an investment property at a bargain-basement price,” she says. “And if your business’ revenue takes a hit, or you lose your job, having a rainy-day fund to fall back on can be useful.”
When it comes to the other asset classes, Morris is reluctant to make predictions. “Bonds are a relatively safe bet but offer modest returns,” she says. “I can imagine scenarios where gold either continues to climb strongly in value or plummets. And it’s equally possible that property and share markets could continue to perform strongly throughout 2021 or fall in a hole.”
It’s impossible to eliminate risk but it can be mitigated through diversification. “If you don’t have all your eggs in one basket, you can offset the losses if one of the asset classes you’ve invested hits a rough patch,” Morris says.
Morris won’t weigh in on whether tech stocks are overvalued and due for a correction. She does warn they are not for the fainthearted. “The shutdowns turbo-charged the digital transformation process, so it’s not surprising companies such as Zoom have benefitted from that,” she says. “I’d just point out that some sort of ‘tech wreck’, like the one that happened in 2000, is not unimaginable.”
Active or passive, value or growth?
Once they’ve worked out their risk profile, the two big decisions inexperienced investors need to make is whether they want to pay someone to try to pick funds that provide consistent dividends or are happy to invest in a low-fee fund and whether they want to invest in shares that could increase in value or ones that appear to be undervalued.
Morris stresses that different options will suit different people but offers the following thoughts. “The upside of active management isn’t so much that you’ll outperform the market when things are going well; it’s that you’ll potentially lose less money when they are going poorly,” she says. “Professional fund managers are good at capping the downside, which is useful in volatile markets. Of course, you have to pay for their expertise and labour, so if you don’t want to do that you might be better off taking a low-fee passive management approach. A third option is to diversify and split your money between active and passive management.”
Morris says growth and value investing both have their pros and cons. She suggests investors consider hedging their bets by having some growth shares and some value ones in their portfolio.
Time to rethink your goals?
Economic activity is the result of countless decisions made by individuals. Australians aren’t necessarily making the same decisions they were before the pandemic hit. That has implications both for the individuals making different life choices and the broader investment environment.
“Many of my clients are now working from their holiday houses, so I don’t find it surprising that many ‘sea change’ property markets are booming,” Morris says. “People invest to accumulate the necessary money to achieve their life goals. Many people have rethought their life goals as a result of COVID-19. Also, I suspect some people decided they are comfortable taking on more risk or, alternatively, resolved to lead a lower-stress life after the events of 2020.”
Some individuals can gauge their risk tolerance, clarify their financial goals and work out an appropriate investment strategy unassisted. But Morris argues most people would benefit from the input of a qualified professional. “One piece of advice I am always happy to give is that when it comes to money-management matters, getting a professional involved usually pays off,” she says.