National Australia Bank’s monthly business survey released on Tuesday morning was a sobering read.
Business conditions were their weakest since May 2009, it showed. The outlook for growth is flat. Slowing mining investment, a high Australian dollar and poor economic conditions globally are expected to weigh on near-term activity.
Local sharemarkets, too, have been down this week, following their regional counterparts on fears of a looming budget crisis – the “fiscal cliff” – in the US.
With news like this, it’s easy to feel nervous.
But there are steps you can take to prepare your portfolio to weather the storms. An appropriate asset allocation is one of your first lines of defence.
A sensible spread of investments – splitting between shares, cash, fixed interest and property – will go a long way to protecting your nest egg. The theory is that losses in one asset class will be compensated for by gains in another, unrelated asset class.
It works. Most of the time.
But remember the financial crisis? When that hit, all asset classes fell.
The apparent failure of diversification shook finance professionals and academics to the core. It led them to question traditional approaches to asset allocation.
Now they’re coming up with new ideas on how to do it.
What can you do?
One emerging method is to split the total pool of wealth into three “buckets”. There are other solutions – AFR Smart Investor January 2013 will have more – but let’s look at those buckets in more detail.
The first bucket is used for short-term income, and will hold mostly cash. John Dani, manager of advice development at Ipac, suggests it should be about two to three years’ worth.
The second bucket tops up the first when it runs low. The third bucket stores longer-term investments: the ones you only want to sell when you’re good and ready – maybe higher growth stocks or alternative assets.
That second bucket is important. It acts as a buffer between the money in the first “need it now!” bucket and the third “don’t touch this!” bucket. It’s also, arguably, the most difficult to manage.
The funds in it don’t need to be at-call but they do need to be available to top up the first bucket when necessary. They also need to have growth potential to counter such things as loss of spending power through inflation.
It’s the asset allocation for that second bucket that Michael Drew, professor of finance at Griffith University’s business school, and Anup Basu, a senior lecturer of finance at Queensland University of Technology, are working on now. They hope to come up with some clever ideas early next year.
Until then, keep calm and carry on with diversification.
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