The Source

Oh, ahh ... I'm glad you asked this one because, I think about it a lot.

Welcome to The Source. I'm Alistair Barker, and today I'll answer 5 questions on asset allocation.

What is asset allocation? I get this question a lot.

So asset allocation is the decision we make on how much of your money we put into various asset classes. So for example, fixed interest, cash, shares, property or infrastructure.

You might be wondering ‘How do we make those decisions?’ I like to think of two common drivers that are a pretty good predictor of where markets can go over time.

And those are what we call outlook and what we call value.

Outlook is, ‘what is the outlook for major economies in terms of their growth, policy, inflation?’

Typically, many investments can't defy the underlying health of an economy. So that's why we look at outlook.

The second is what we call valuations or value. So that is, ‘what are we paying for an asset?’

And typically, we want to be buying more of an asset when that valuation is cheap.

And selling more of that asset when the valuation is expensive.

So when you combine outlook and value together, you get a coherent picture of what the prospects are for a particular asset class, but also what you're paying for it.

What’s the difference between a proactive and a reactive investor mindset?

The conundrum here is you actually need to have a bit of both. If you're not being proactive, you're not anticipating what the future dynamics will be in the world and in the investment market.

So you have to start from the position of being proactive. But by the same token, there are instances where you'll need to be reactive.

I'm sure you can all think of an instance where you thought something might pan out, whether it's in your life or in the world, and there was some event that resulted in a distinct change from what you thought.

In my role and with my team, we talk a lot about what the future of the world will be and how we position portfolios that you're in. But every now and then the world changes.

We're spending 80% of our time being proactive. But there is that 20% of the time where you have to acknowledge that your views have evolved and you need to change.

What are some common questions that DIY investors ask me when they want to get more hands on?

Well, there's a few.

The critical things I think about are, what are the principles I use when I manage my own money?

What are the key lessons I think about to make sure that I avoid, the worst mistakes I see in the professional investing world.

And those are really simple principles. Making regular and staged investments. As we call it, dollar cost averaging, is typically the best path of least regret if you're looking to invest over time.

The second is diversification. It's about the only free lunch there is in investing. If you look at really professional investors, they never bet their entire portfolio on one particular thing. No matter how good you are, it's irresponsible to do that.

I encourage people to think about partnering, how much conviction or how much skill they have in an idea with what's the risk they're wrong? Those would be the two sort of common themes that come up when I talk to people, is dollar cost averaging and diversification. It's boring and it's simple, but it works.

How do you manage risk when you invest?

I think this is one of the greatest sort of misconceptions or misunderstandings in the world of investing. I think about breaking down risk into three different words.

Uncertainty, volatility and risk.

Uncertainty is what you see on the TV or read in the newspapers. It's the fact that at any stage there's usually issues that are unclear. There are uncertainties about what's going on in the world. So that's uncertainty.

Volatility is what financial markets do in reaction to that uncertainty. So there might be a news announcement, and then financial markets that day have reacted to that particular bit of news.

Uncertainty leads to volatility. Now neither of those are really risk.

So when I think about risk I think about the risk of achieving an outcome. So what do I mean there?

What's the risks that we can't keep pace or outperform inflation?

In the very long run, the biggest risks that many of you face is that your savings can't keep pace with inflation and your consumption in retirement is less as a result.

So when I think about risk, I think about the risk of not achieving an outcome.

And that's very distinct from volatility and uncertainty that you see in financial markets and in newspapers on a day-to-day basis.

What do I think about the risk of losing money in an asset?

It's an occupational hazard. The critical thing I think about is diversification. Any one investment could lose money, but a portfolio has to be diversified against key risks. Losses can and do happen from time to time. No one wants to have them. No one seeks to have them. But financial markets can be uncertain.

And so the best safe harbours are diversification and also time, to wait for and to see returns on a portfolio manifest is quite critical.

Thanks for watching today. I hope that these questions and my thoughts on them provide you a bit better sense of how I think about investing, and how we think about looking after your savings, because it's a genuine privilege to look after your money.