Investing

Positioning your portfolio for the worst-case scenario might seem overly pessimistic but in this uncertain environment it could also be prudent. Having survived the ups and downs of 2011, the last thing your portfolio needs is a further setback.

The key concern for most investors is the pace at which global economic events are changing. Just as it looked like the European debt crisis was under control, credit downgrades to several countries came as a kick in the teeth.

Closer to home, concern that China’s growth may not be sustainable hangs over Australia’s already choppy economy.

Stages of life

If there is a unanimous view on the outlook for financial markets it is that volatility is here for a while yet. What that means for portfolios will largely depend on where you are in life: a retiree desperate to preserve a lifetime of savings will take a very different view to someone with a 20-year time frame.

HSBC Bank’s head of savings and investments, Mike Danby, says that, with prolonged volatility, diversification and long-term investing have become all the more relevant.

He says that if you take the view that short termism is driving sentiment and emotion, then it is important to look at longer-term pricing and opportunities.

Where historically staying invested has been a passive buy-and-hold approach, today it means reviewing and rebalancing your portfolio regularly to capture opportunities and mitigate risks.

Reassess your situation:

The saying goes that if you can’t stand the heat, get out of the kitchen. Well, if you really can’t take any more equity market volatility and you don’t have a decade to enjoy the smoothing effect of time, now might be the time to cut some losses and seek wealth elsewhere.

While having everything in cash might seem like the ultimate safe haven, even the short-term returns may not keep up with inflation and your money will quickly erode.

An investor with considerable holdings who would feel better out of the market altogether could think about selling and putting some money in the bank, but do it gradually, says PSK Financial Services adviser, James Gerrard.

Crystallise losses

“If selling means realising losses then now might not be the time to do it, but if it is going to help emotionally then you might incrementally build a pool of cash,” he says.

Without the benefit of a crystal ball to tell whether things are going to improve or worsen, Gerrard suggests people position the equities component of their portfolio in case something bad happens.

Rather than moving entirely into cash, he advocates selling small cap stocks, which are by nature more volatile, or growth stocks which are vulnerable to overseas shocks, and buying defensive stocks.

Flight to quality

Stocks likely to continue to pay a dividend regardless of a fall in the share price, such as the banks, are also worth hanging onto.

“Woolworths, CSL and AGL are stocks that held their value during the GFC and should continue to do so if the economy starts to slow,” Gerrard says.

Cameron Howlett, principal of Melbourne-based Personal Wealth Advisers, says clients often have a portfolio of 10 to 12 good quality stocks and those they bought pre or during the GFC that have failed to go anywhere and even retreated.

By good quality, he means companies with lower levels of gearing, consistent and maintainable earnings and dividends. “Clean out the rubbish and get back to basics,” he says.

Income or growth?

Much of what you have in your portfolio will depend on whether you are looking for income or growth. If income is important then make sure you are invested to receive it regardless of what the underlying asset does, Howlett says.

In the case of stocks it means buying stocks paying a good and hopefully fully franked dividend. The share price might move up and down but the dividend should remain constant.

In fixed interest, the price of bonds also fluctuates but the income paid can remain the same throughout the term of the bond.

It is important to remember all investment returns are the same regardless of whether they are income-generating or growth-oriented, says Prescott Securities financial adviser David Middleton.

That is, total investment return includes the changing value as well as income. People often overlook the income or forget that they’ve had it.

Seize the moment

“Right now, there is good income available and investors should grab it,” says Middleton. “You just need to know where to look and how to manage your risk. It is possible to get a risk-free 5 per cent from a term deposit in a bank or, if you are prepared to put up with some volatility, you can own shares in the same bank and get a 10 per cent return.

“As long as you can switch off and just take the income then, when a recovery comes along, the value of these relatively conservative investments will improve.”

Middleton says the key is to focus on high-quality investments with low debt and solid yields funded entirely from free cash flow.

Three pools

John Donald, principal and senior adviser with Perth-based RMG Financial Services, says it is important investors are across the time frames they have to invest in and what they can control with respect to their finances.

Portfolios should have three distinct pools: one might be wholly in cash to meet short-term expenses; one might be in a mix of income and growth assets for medium-term expenses; and one might be in growth assets for the longer term.