Investment Research Group
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Don’t be afraid to take profits Human beings are hot wired to think that present conditions will continue into the future. Given most assets in New Zealand went up in value at a record rate last year, particularly shares and property, logic would suggest 2005 will be less robust. You have to remember that all categories of investments grow by an average rate over the long term. After a period of above average growth, the following years are often below average. The assets that delivered the best gains last year are now likely to represent a larger percentage of your total net wealth than they did a year ago, so it would be prudent to take a little out of those and bump up your exposure to other (potentially cheaper) assets. Some people work out the percentage they need to hold in each category of investment when assembling their portfolio, and every year will buy and sell investments to return to those percentages. When taking profits, you don't have to sell all of a bond or share holding, just a portion. This gives you exposure to potential upside while reducing pain on the downside.
Look at yields, not prices When markets take off like they have in this country in the past couple of years, people start thinking in terms of how quickly they can make profits. As a result, they stop thinking about what an asset is worth to them in terms of income - normally the only reason for buying an asset - and start thinking solely about capital gains. This can become a vicious game of pass-the-asset where eventually someone will be left holding an investment that nobody wants to buy and the price will plummet. It makes sense only to buy as asset that produces an income in line with risk. In other words, buying an investment property or share with a yield no greater than the rate of inflation is asking for trouble.
Remember that assets are not money Seeing the value of the family home going up is not the same as seeing your deposit of cash in the bank growing. An increase in personal property equity is equivalent to having a permit to borrow money - and many do. Don't forget that asset values can go down, however, while debts (and resulting interest payments) don't, unless they are paid off. Unfortunately, if recession were to strike, many people's ability to service their debts declines at the same time as their asset values.
Remember to diversify Because nobody can read the future, you need to own a spread of assets that can withstand almost anything that is thrown at you. Some think that the wider you spread, the better. But this has been disproved, and the feeling now is that how you combine investments is more important than how many categories of investment you hold.
In a portfolio of shares, for example, certain shares will be very vulnerable to a rise in interest rates, others not. It is important to have a share portfolio that is not over exposed to a single type of risk, such as a rise in interest rates.
If, for example, you own an investment property, shares in New Zealand companies and you work in a job, you could be completely exposed to the cycles of a single, small economy - New Zealand’s. Investing in Australian shares and property, for example, or investing further abroad can offset some of that risk.
