Where would you invest $10,000?

In the financial services industry we talk at length about asset allocation, spreading risk and the risk-return curve.

But when Australians talk about saving for their retirements it’s the basic idea of the diversified portfolio which is most important.

I was thinking about this recently after I put out a Twitter asking where followers would put $10,000 for a year if I gave them the money.

Two-thirds of the responses would put their $10k into shares, property or cash but not a single person told me that they’d split the $10k and invest it in different asset classes.

None of the almost 70 people who responded to me said: “I’d put $4000 into shares and $3000 into a property trust and $3000 into a fixed interest account.”

The fund management and financial advisory industries have spent the past 20 years emphasising the benefits of a diversified portfolio and spreading your risk, and at the base of a diversified portfolio is asset allocation.

Allocating investments by class means devoting parts of your capital to Aussie shares, part to global shares, part to cash, part to property and part to bonds.

Then you match the ratios of your allocation with what is known as your life stage.

If you’re 20 your allocation will be heavier to Aussie and global equities, because the amount of time you’re invested will cancel out the volatility cycles and you’ll get higher returns.

When you’re a retiree or a near-retiree you shift the weighting of your allocation to be heavier in cash and fixed interest because while they’re lower in returns they’re high in stability.

While these dramatic shifts in asset allocation have become par for the course I’ve been rethinking it lately.

Allocating assets by investment class has an extreme look to it. The two main risks that retirement savers face are market risk and inflation risk.

You expose yourself to market risk because you chase higher returns and that means you’ve invested in volatile equities.

Inflation risk occurs because you’re chasing low risk, which means investing in cash that hovers very close to the inflation rate.

Secondly, we are encouraged to skew our retirement investments to market risk or inflation risk, by the default options at our superannuation fund managers.

If you tick default for most of your accumulation phase you’ll be invested 60-70% in equities and when you identify that you’re about to retire most default funds switch you to reliance on cash investments.

That is a pendulum and it might not be as successful as we imagine.

How do we stop the pendulum?

The asset class called bonds – halfway between the risk/return of equities and cash – is a better long-term performer than Aussie equities, with very little volatility.

I believe the issue of asset allocation will be revisited in this post-GFC market and we’ll come to see it as a chance to properly balance a portfolio from the outset rather than change the risk profile to match life stages.

Keep an eye on bonds – they’ll be a part of that change.