Ingredients of a Good Personal Financial Plan – Part 1 Portfolio Management

Posted on: 03/11/2020

Raffi Pailagian
MBA, BSc, DipFP
Financial Planner / Managing Partner

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Categories: Financial Planning & Advice Holistic Planning & Advice Investing Retirement Financial Planning Wealth Management

Ingredients of a Good Personal Financial Plan – Portfolio Management

Creating a good personal financial plan is a lot like baking a cake. If you leave one element out, or get the ratios wrong, it won’t rise properly and you won’t get the results you are hoping for.

Over the next couple of weeks we will be looking at the key components of a perfectly prepared financial plan, namely:

Portfolio Management
Property
Mortgages
Superannuation and SMSF
Insurance
Tax
Estate Planning

Each of these elements needs to be given proper consideration in its own right, and in relation to each of the other components, so that you have a balanced whole.

Why an Investment Portfolio is Important

Each component of a good financial plan plays a role. In the case of your Investment Portfolio, there are a number of reasons it is important:

Because these investments are more liquid than say, property, it means your money can be moved quickly to take advantage of unexpected opportunities
Investing in stocks, bonds and the like, despite the ups and downs of the markets, can yield great returns, especially if managed by a thorough and knowledgeable financial planner
A portfolio of investments can be structured to provide you with both growth and income which can help you achieve short and long term goals
That word again – diversification. You don’t want all your eggs in one basket, and an investment portfolio allows you to diversify. Both within the portfolio and in your overall plan

What is Portfolio Management

Simply put Portfolio Management is the selection and supervision of a range of assets to meet the financial goals of an investor. But nothing is ever quite as simple as it seems.

In structuring a successful portfolio of investments there are trade-offs that need to be made. Risk vs return; active vs passive; growth vs income, and the list goes on.

Within a portfolio you can, and should, have a range of different asset classes. They may include shares, bonds, cash, commodities. But you may also have art, property trusts and other investment types.

How to Structure a Portfolio

There are a number of factors you need to take into consideration when deciding what asset classes, and within that, what specific investments, to include in your portfolio:

Time – your time horizon is critical to decision making on investments. When you are just starting out, you have plenty of time to take risks and recover. You are also probably more likely to be looking at growth-based investments. If you are close to retirement you will be starting to look at income-generating investments with lower risk profiles, even if you have a natural leaning towards high risk investments. Five years out from retirement is not the time to bet the farm!
Diversification – regardless of your level of risk tolerance, your portfolio should contain a diverse range of investments. Including assets with negative correlation[i] will help balance any potential falls. When assets have a negative correlation they typically move in opposite directions, so when one is falling, the other will be rising
Risk – we’ve said it before, but it can’t be stressed highly enough. Every asset you include should be looked at through the lens of your own Risk Profile. If you haven’t read our article on Modern Portfolio Theory and the Efficient Frontier it will help you understand risk and why it is so important
Goals – whether your goal is to have a specific net worth by retirement, or to generate income in the present, or even a little of both, you need to be clear on your goal as it will drive what investment opportunities you choose
Ethics – ethical investing is becoming more and more important to many investors[ii]. You may have grave concerns for the environment so investing in renewable energies rather than fossil fuels may appeal. Perhaps you have concerns about working conditions in developing economies, so certain companies might not be suitable. Whatever your concern, investing in companies that address these concerns allows you a clear conscience

Types of Portfolios

There are as many types of Portfolios as there are investors, but there are some broad styles that you can use as a starting point.

Income Portfolio – which, as the name suggests, focuses on income producing assets rather than growth. This type of portfolio is generally preferred in retirement.
Defensive Portfolio – includes blue chip and household names. It will generally do well in bad times, but is unlikely to achieve the great highs of riskier investments,
Aggressive Portfolio – investments in this type of portfolio are often in new markets. No household names here. While the returns can be great, so can the losses.
Speculative Portfolio – Maybe the highest risk style of portfolio. This portfolio often includes technology and health-breakthrough investments.
Hybrid Portfolio – the hallmark of this portfolio is good diversification across asset classes and a high degree of negative correlation.
Tactical Portfolio – a portfolio structured to meet short or medium term needs, rather than long term goals.
Strategic Portfolio – A portfolio specifically structured for long-term needs, typically to build assets for retirement.

Of course, any portfolio can, and possibly should, incorporate all of the above types of investment strategies. Over the lifetime of your portfolio, you may move from Speculative, through Aggressive to Defensive as you move from wealth building to income generating in retirement. The beauty of investing is the ability to rebalance as your needs change.

Finally…

Whatever the makeup of your Portfolio is, it is important to keep a close eye on market shifts, the world economy, the political climate, and even natural disasters and weather events. All of these can impact the performance of your portfolio.

This is why it is important to have an experienced, qualified financial planner you can trust. Because it’s not just about what to buy, but when, as well as how it fits with the rest of your financial plan.

In our next article, we will look at the role of Property in your Financial Plan. From your family home to investment properties, we will help you understand when and how to invest.

When you want to chat about getting started on a Financial Plan, or looking at the effectiveness of the one you already have, please contact us on 02 9976 3388 or click below and we’ll be in touch:

Interested in knowing more?

[i] https://corporatefinanceinstitute.com/resources/knowledge/finance/negative-correlation/
[ii] https://www.afr.com/companies/financial-services/ethical-investments-soar-to-nearly-1-trillion-20190702-p5239b