In response to Marcus Padley from the Age – Click Here
Harold – a four stock portfolio? Really? I can see what you’re cooking and I believe it’s based upon a recipe for disaster.
So, we have Harold (a retiree) who lives the retirement dream and thinks his dream should be solely supported by the banks and their future viability.
The above pic is how I see Harold’s situation in a pictorial format. Harold is metaphorically jumping off the cliff.
Like many Australians expecting to enjoy their retirement, Harold has built up his portfolio with years of hard work, sweat and tears. It would be unfortunate – disastrous even- should his ongoing lifestyle be compromised by his portfolio ‘falling off the cliff’ due to lack of diversity in his retirement plan.
Harold asserts he likes the idea of investing his whole portfolio in the major bank stocks. This is concerning. While the comforts of investing at home in familiar ‘blue chip’ stocks is alluring, Australia makes up only about 3 per cent of total world equity market capitalisation. Most Aussies are unaware of the risk they are taking by having an overexposure to only a few local stocks. Many have been blindsided by exceptional returns over the last 10 years in growth investments on the back of our mining boom and Asian growth and may be forgetting to focus on the risks of having a disproportionate balance of equities to bonds in their portfolios.
Yes, the banking sector has performed exceptionally well in the face of the Global Financial Crisis, however, this does not necessarily translate into a great return for investors. For Harold to achieve a great return from the banks, he would need to exhibit calmness and remain strategically invested especially when markets are volatile. That is not a given. It is human nature to make spur of the moment decisions during market peaks and troughs, particularly when your total retirement capital is at the mercy of just four stocks. Most likely, Harold would be no exception to this. As Carl Richards rightly states: ‘When we diversify, we’re setting up guardrails to help us make smart, disciplined decisions’. For instance, what would Harold do should one of his stocks take a 40% nose dive? Odds are that Harold and many other astute investors would be looking around for another stock that could unwind the hurt already experienced. Such an approach would be consistent with the classic ‘fear and greed’ cycle which impacts overall investor returns over time.
Harold also states that the bigger your retirement fund, the more risk it can take and that there comes a time, as you get older, when you can get ahead of your cost curve and therefore become more willing to take risks. Harold has forgotten about a particularly important aspect of retirement planning, that is, sequencing risk.
Sequencing is the risk of differing performance due to the pattern in which returns are realised by investors. This pattern plays a critical role in determining the ultimate value of retirement savings and their longer-term sustainability. So in Harold’s instance, a prolonged downturn in either Australia’s fortunes or in a single banking stock’s profitability, would come at a very unfortunate time because he has the most to lose ‘now’ as his portfolio is close to maximum value. Take a look at the diagram below: if a negative 10% return was realised in phase C, Harold would be pretty unhappy, as indicated by his facial expression.
What compounds the pain for Harold is that he will need to draw an income stream during phase C when his portfolio needs a chance to recover from the losses that have been experienced. In summary, I think we need to be careful about making sweeping statements about the lack of merit of diversity. I am, however, buoyed that Harold will provide some more advice in his next instalment. We can only hope that he reads this and adds a little more diversity.