Study after study indicates that virtually no one – not even the experts, fund managers or sharebrokers – can successfully and consistently forecast economic events, interest rates, exchange rates, or pick the right bonds, properties, or shares/ stocks, year in and year out.
It therefore follows that no one can pick the best investment class to be in right now. In my opinion there is no such thing a single “best investment.”
For most of us, a diversified portfolio is probably the best solution.
High quality bonds form the foundation of an investment portfolio, since they are low risk, and can be bought and sold at any time. Diversification over 100+ bonds is easily achieved by using the DFA bond funds offshore and perhaps some of the AMP bond funds onshore. For the most part they pay income of about 1% to 2% better than the bank too.
But there is no growth, values can fall if interest rates rise sharply, right now they are very expensive and it is hard to get a decent yield.
Easy to do via listed property shares. It is possible to get quite a good yield of 3% to 4% more than a bank, and diversification is quite easy to achieve as each of the funds we discussed holds 50 or more properties. They are liquid too because they are listed on the sharemarket.
However they are all in NZ, a very small country with a narrow economy, and their share prices are pulled up and down with the sharemarket as a whole. In an economic downturn, they can lose the odd tenant and have vacant space, so the rent /yield can fall.
The yield on most rental properties in reasonably buoyant towns in NZ is about 3%. Additional return has to come from capital gain, but you cannot spend the capital gain (if you need income) until you sell the house.
You can get yields as high as 8% to 10% if you buy a house in a very depressed town and rely on the rent being underwritten by WINZ. There is unlikely to be much (if any) capital gain, and this kind of investment is not everybody’s cup of tea either.
Residential property investment is probably more suitable for younger people do not need income and are seeking long-term capital gains. It is perhaps less suitable for those who are nearing retirement, or are retired, and need a good income stream.
Tenants can be a problem (possible damage or rent arrears) and tenants are perhaps over protected by the law. Diversification is hard to get, and liquidity is an issue too, you just cannot get money out a house quickly.
In good times the returns from shares can easily exceed the returns from bonds and property. It is easy to get diversified, by using the NZX50 onshore which holds 50 NZ shares, and various funds offshore such as DFA holding up to 5,000 shares.
Provided you are diversified, liquidity is not usually a problem, shares can be sold and you can get your hands on some cash within 7-14 days.
The weakness of shares is fourfold – they do go up and down, all too often they are much misunderstood, and too many people try to forecast and stock pick, which rarely works. Last but not least, human nature gets in the way, with too many investors buying in when things are good / shares are expensive (driven by greed), and selling out when things look bad (driven by fear), and sell out at low prices.
When investing in shares;
- buy in when things don’t look so good, and /or average in
- you must be disciplined and be prepared to wait
What proportions ?
Younger people who do not need income and are seeking longer term growth should have about 70% in shares, 10% property and 20% in bonds.
People who are near retirement, or are retired, and need income, should have about 65% bonds, 10% property, and 25% in shares.
People who have about 8 to 12 years to go to retirement should be balanced at 45/10/45.
The global financial crisis of 2008 and 2009 was a major test of investment funds. The DFA bond funds continued throughout the crisis without a blip and continued to average over 7% pa.
All share funds including DFA went down, but the DFA share funds have been rising again quite nicely since March 2009. At no point were any of the DFA share funds impaired or frozen in any way – they remained liquid throughout.
By using a diversified portfolio of these funds, your risk is not the risk of a fund failure or total loss – rather it is the volatility from rising and falling share markets, but remember (historically at least) shares have a lot more ups than downs.