Personal Asset Management

Investment Strategies:

When constructing a portfolio, we consider the following objectives: current income needs, capital preservation, capital growth, tax considerations and risk.

As your current income needs are met and still leave you with a net saving capacity of $39,696.65 left for investments, this is not your primary concern.

Capital preservation is an investment strategy where the primary goal of the investor is to preserve capital and prevent a loss in the portfolio. This is of maximum priority for retirees and those approaching the retirement age (Capital Preservation, n.d). Investors in this situation rely on their investments to generate income to cover living expenses in order to maintain their current lifestyle.

On the other hand capital growth is an investment strategy where the investment increases in value over time. As you currently have no debts or liabilities to cover and do not foresee any change in your expenditure and expect that 50% of your current salary will be more than enough for you both to maintain your current lifestyle, capital growth is not the best suited option. In order to sustain a capital growth investment portfolio the level of risk is increased (meaning there is more chance of a loss) and there is a reduced amount of current income which will prevent you from continuing with your current lifestyle (Capital Growth, n.d). These high risk investments provide much higher returns but there is potential for much larger losses.

As capital preservation is your prime objective in order to have enough money to maintain your lifestyle during your retirement, you are best suited to a capital preservation investment strategy. Based on calculations in the Risk Assessment section of this report after all expenses you are left with $39,696.65 in your net savings capacity which can be used in these investment decisions. Under this portfolio orientation we look to conservative, low risk investments. These low risk investments provide relatively predictable returns.

The aim of selecting the Capital Preservation portfolio is to provide a stable and reliable dividend income from companies that hold minimal risk of bankruptcy.

As you are a high income earner and are currently paying a large amount of tax, tax considerations are also a deciding factor in your investment decision. You may wish to defer taxes and earn investment returns in the form of capital gains (Gitman et al. 2011). Under this portfolio orientation we look to higher risk investments and require a longer holding period.

Portfolio Construction – Asset Allocation:

Now that your specific portfolio objectives have been identified, we can now construct a portfolio designed to achieve these goals. The main objective of asset allocation if the preserve capital through investment in various asset classes (Gitman et al.2011). Prior to buying any investments, you need to develop an asset allocation scheme. This divides your portfolio into the different asset classes – shares, bonds, foreign securities etc.

There are three basic approaches to asset allocation:

1. Fixed weightings
2. Flexible weightings
3. Tactical asset allocation

Fixed Weightings: allocate a fixed percentage of the portfolio to each of the asset categories of where there are typically 3-5. These fixed weightings do not change over time.

Flexible weightings: are periodically adjusted for each asset classed on the basis of market analysis. Changes are triggered by shifts in market conditions or expectations.

Tactical Asset Allocation: is a form of market timing that uses chare index futures and bond futures to change the asset allocations of a portfolio.

As you have decided to take on the investment process yourself and not introduce professional help, I suggest a fixed weighting approach which remains constant and requires no changes.

There are three different ways to determine your asset allocation weightings.

1. Conservative
2. Moderate
3. Aggressive

The conservative approach to fixed weighting asset allocation relies on bonds and short term securities to provide predictable returns.

Moderate allocation relies on shares and bones and includes more foreign investments and fewer short tern securities than that conservative approach.

Aggressive allocation relies on investing more funds in shares, fewer in bonds and more in foreign securities – generally increasing the expected portfolio return and risk.

The different approaches and their asset allocation weightings can be seen below:

Portfolio Recommendations:

Based on the questionnaire we conducted earlier (see client questions and answers), we compiled your risk profile score. Based on this score we found that you belong to a moderate profile of risk. This means you don’t mind minute fluctuations in investment returns, but would be uncomfortable with great fluctuations as security of your investment is paramount. As such I recommend the Moderate Asset Allocation Alternative.

Based on your conservative approach to asset allocation, 30% of capital should be invested in shares and property with the rest being invested in cash or fixed interest securities. An investment of $10,000 after five years will leave you with $12,300 equating to an expected return of 4.2% before fees, taxes and other costs (Super Investment Options, 2015).

Shares:

The benefits of investing in shares include the strong growth potential, possible income arising from the payment of dividends and if your situation changes and you need to access your money they can be bought or sold quickly (Choosing Investments To Suit You, n.d). These shares are suitable if you’re looking to supplement or replace an income ie. When you are approaching retirement. Property is also of a great benefit to your situation as it is a long term investment and can possible result in rental income from investment properties. 30% of capital should be allocated to this asset class.

The timeframe over which the capital is to be preserved determines the blend of investments to undertake. For longer capital preservation periods, fixed income securities which includes bonds that are highly rated by a credit ratings agency are best suited.

A well-diversified portfolio compiled of five leading companies which provide the potential for regular dividend income are listed below. Each company is listed in the ASX top 50 listed companies. In order to diversify your investment we have distributed suggested shares purchases amongst different sectors. As we have $39696.65 in our net saving capacity, 30% of this ($11,908) should be invested in these shares.

Andrew & Margaret’s Share Portfolio

Bonds:

40% of capital should be allocated to fixed interest bonds. The benefits of fixed interest bonds include the payment of regular interest at a higher rate than that of cash investments, predictable returns and the ability to buy or sell quickly in the event that you need to access your money (Choosing Investments to Suit You, n.d).

You should prefer to invest in companies that are deemed to be undervalued with established, proved business models, a record of recurring earnings and dividends, conservative balance sheets and competent, ethical and shareholder-focused management and directors.

As we are looking for investment capital for a longer time horizon as you are 15 years away from the retirement age, we look to those choices that provide longer time horizons. An example of a security that would be suitable in your situation is 10 year Australian Commonwealth Government bonds. Even though the yield on these bonds is only equal to 3.5% per annum, the likelihood of an investor getting their capital back is high probable (Investment Strategy, 2014).

Based on your allocation method are allocating 40% of capital to fixed interest bonds (14,787.86).

Fixed Rate Government bonds that are currently available for purchase are listed below:

Corporate bonds should also be considered as they provide regular interest payments from the issuing company for the lifetime of the bond with the principal amount being repaid on maturity

Foreign Securities:

An allocation of 15% of capital should be allocated to these foreign securities ($5,545).

Short Term Securities:

For shorter capital preservation periods, cash investments and bank term deposits are preferred.

A bank term deposit allows you to secure your money with a fixed interest rate for a set term (from one month to five years) (Different Types of Investments, n.d). The interest rate paid for amounts deposited into the term deposit account depend on the term of the account. An allocation of 15% of capital (36969.65) should be allocated to these short term securities ($5,545) See the below table for more information:

To maximise the amount of interest earned on money deposited in the term deposit, the entire allocation amount of $5,545 should be invested for the 60 month term as this provides a higher rate of interest and interest payments are made more frequently than the shorter term periods.

Tax Effect: Investors who earn interest income are required to pay tax. Share investors are given franking credits on the dividend income for the income taxes already paid by the corporation. Share investors like yourself also receive a gain in the value of their shares knows as capital gains of which only half is taxable. Capital gains are only realised through the sale of the shares when sold at a profit (ie. At a higher price than when it was originally purchased). If the shares are not sold and held by the investor, no capital gain tax is recognised. This allows you to defer tax payments as well as control their timing as tax is only payable on the sale of the shares.

References:

Simple Tax Calculator, Australian Taxation Office, viewed 3^rd October 2015, <https://www.ato.gov.au/Calculators-and-tools/Simple-tax-calculator/>

Capital Preservation, Investopedia, viewed 3^rd October 2015, <http://www.investopedia.com/terms/p/preservationofcapital.asp>

Capital Growth, Investopedia, viewed 3^rd October 2015, <http://www.investopedia.com/terms/c/capital-growth.asp>

Gitman, L, Joehnk, M, Juchau, R, Donald, G, Wright, S 2011, Fundamentals of Investing, Pearson Australia, Australia

Super Investment Options, ASIC’s MoneySmart, viewed 3^rd October 2015, <https://www.moneysmart.gov.au/superannuation-and-retirement/how-super-works/super-investment-options>

Choosing Investments to Suit You, Commonwealth Bank of Australia, viewed 3^rd October, 2015, < https://www.commbank.com.au/personal/can/investing-your-money/choosing-investments-to-suit-you.html>

Investment Strategy: Objective Based Investment Strategy, National Australia Bank, viewed 3^rd October 2015, < http://business.nab.com.au/investment-strategy-objective-based-investment-strategies-7931/>

Different Types of Investments, Commonwealth Bank of Australia, viewed 3^rd October 2015, < https://www.commbank.com.au/personal/can/investing-your-money/different-types-of-investments.html>