Sunday 7th of August 2011

Too many advisers remain fixated on the outmoded income or growth bias when constructing portfolios. This is short-sighted and leaves the client losing out on returns they could achieve in many economic cycles, as well as living less comfortably than they could. There is only one optimal way to construct a portfolio – to maximise Total Returns (within a given risk profile). Then all one needs to do is manage drawings as an annuity, keeping the portfolio in line with future financial planning. The objective is to put the investor’s needs first. The individual’s cost-of-living does not change with the fluctuations of a portfolio’s ability to produce income, and nor should it. Those still trying to construct a portfolio looking for income investments to match clients' cost-of-living are doing their clients a disservice. They may also be subjecting the client to more taxes than is necessary. Part of this misguided mode of constructing portfolios comes from old trusts that were structured with ‘Income’ benefits to surviving partners and residual ‘Capital’ to other beneficiaries. We all know the court cases of this misguided approach when trustees focused excessively on the surviving partner not taking sufficient account of capital beneficiaries’ rights - and hence not growing capital to even modestly keep pace with inflation. ‘Income’ and ‘Capital’ beneficiaries’ interests must be, and can be balanced. Another reason for some advisers not pursuing total returns may be that they do not manage the cash component of their clients’ portfolios very well. Cash is an asset class. Beyond receiving interest, coupons, dividends and distribution, a cash component to a portfolio is essential to facilitate rebalancing and re-investing. People giving free advice in the mainstream media have recently bewailed a perceived ‘gap’ exists in New Zealand with few annuity funds available for people to utilise when they get to the age they can pull money out of their KiwiSaver scheme savings. A balanced fund is just such a scheme and can readily be utilised to meet cashing-up KiwiSaver’s required expenditure in retirement. Also consider, that annuities (and I am sure there will be a plethora of them in New Zealand shortly as the insurance companies look to make a buck) consist of an underlying pool akin to balanced fund, one from which the insurance company pays out the regular annuity and pockets the remaining portfolio for itself as the profit. Of course the annuity does spread the risk that an investor will outlive drawings from their own portfolio, by packaging their odds with another poor devil who dies early and misses out on both income and capital. But this can be countered by really good financial advice, calculating and fostering sufficient client savings (portfolio) to outlast their lifetime of drawings. Investors with a good level of savings will be more efficiently served to go for the self managed balance portfolio or fund approach. A warning - don't get glassy-eyed when the avaricious insurance companies come to town with their glossily packaged, ‘new’ annuity products. You can be sure their actuaries will have worked out a handsome profit. Doing what is best for clients may be managing the portfolio for Total Returns, keeping residual capital for the client’s estate. Added value for your clients is a fee well-earned.