Superannuation is not an investment! Superannuation is simply a trust structure that holds your investments in accordance to the rules of the trust. The major driver behind your superannuation investment returns is the asset allocation in your superannuation fund – This is a professional post by Financial Adviser Charles Badenach
Asset allocation of a superannuation portfolio
This simply refers to where and how much you have invested in each asset class.
Assets are normally classed as cash, fixed interest (Government and corporate bonds), property, Australian shares and International investments. Each asset class will have a different level of return and risk depending on the underlying economic conditions at the time. By diversifying amongst and within each of the asset classes, the overall risk of the portfolio is reduced.
For many people, setting the asset allocation can be a nightmare and they simply put their head in the sand and let the fund choose. We are lucky in this country in that nearly all of the superannuation funds provide what is known as a default asset allocation. In simple terms this means that the superannuation will develop an asset allocation that will ‘hopefully’ suit the majority of the members in the fund.
In most instances, superannuation funds will have a balanced asset allocation as default option made up approximately as follows:
A balanced asset allocation usually consists of a mix of shares and bonds, property, infrastructure, alternative assets and cash.
What these default funds often fail to take into account is that the “one size does not fit all” approach, may be appropriate for one person but not be appropriate for another person.
Determining an appropriate asset allocation is an important decision as approximately 70-80% of the return is determined by the asset class in which you invest in.
A simple solution
Many investors use the old rule of thumb that you subtract your age from 100 and that’s the percentage of your portfolio that you should keep in growth assets. For example if you are 40 you should consider having at least 60% of your portfolio in growth assets. If your 60 an allocation of 40% may be more appropriate.
This rule of thumb is based on the notion that when you are young you need growth, you can afford to take risks as you have a long period to make up any money you lose. However when we get older the time period left to recover is less so we need to adopt a more conservative approach. This is particularly the case when you enter what I refer to as the “retirement risk zone” the 5 years before and the 5 years after retirement.
What you need to remember?
We are all different and what is a suitable asset allocation for one person may not be suitable for another person. You are the only person who knows what level of risk you feel comfortable with. There is no point having an asset allocation that keeps you awake at night.
However when considering what is an appropriate asset allocation for you, here are three points to remember:
- Different asset classes offer different returns and risks. This is often referred to as the “risk-return tradeoff” which means the more risk you take the higher your expected return is over the long term. This is not always the case as the recent falls in the Global Financial crisis highlighted when at one stage some Australian listed property trusts fell over 80% in value.
- Determine your long and short term goals
- Time is your friend and use this to your advantage. Having a reasonable investment time period allows you to take advantage of compounding, the time value of money and also ride out any periods of poor investment returns.
However, there is no perfect asset allocation but you can get it horribly wrong if you don’t take a little care. Asset allocation is an ongoing process and just like a motor vehicle requires servicing from time to time.