Asset mix is best way to invest

I'M OFTEN asked to explain what is meant by asset allocation which, when it comes to investing, is the most critical decision you need to make when putting a financial plan together.

There is a difference between investment and lifestyle assets.

Lifestyle assets include your home, vehicles, furniture, clothing, jewellery, cash and deposits. They generally don't provide an investment return and although included in your personal balance sheet, should be excluded when formulating your asset strategy.

Before deciding how to invest, it is important to understand the predictability of the following asset classes:

1. Fixed deposits, Money Market and cash. The amount invested will grow by the rate of interest and will not beat inflation after tax.

2. Bonds - provide interest, which is taxable and the value will fluctuate, depending on interest rates.

3. Property - value will grow over time, but be aware of issues with tenants, maintenance and associated costs.

4. Equities - long-term growth encompassing extreme volatility. However, dividends are tax-free and capital value will beat inflation and will be tax-efficient over the long-term.

Young people need to be in growth assets. To illustrate this point, an example follows:

• Your current after tax income is R30 000;
• Your age is 35;
• R15000 in monthly expenses relate to your bond, education and car leases.

Having projected ahead to age 60 (25 years ahead) - your position should be:

• Bond, education, car leases have fallen away;

• Monthly income required = R65000. I've used a 6percent inflation rate;

• Capital required to provide income well into your 90's = R14,5 million;

• A 3,5 percent net return above inflation and after tax has been assumed.

Now, I'd like to make the comparison had you invested conservatively, versus a growth portfolio. This is illustrated by showing how much you would need to be invested, a year, based on:

• 7percent return = R230 000
• 12percent return = R108000

Have I been unrealistic in assuming a 12percent return? Equities over the last 25 years have achieved growth of between 8 and 10percent above inflation. Although there have been periods when they have fallen significantly, by as much as 45percent, those who sat tight and made adjustments when necessary have achieved the superior returns.

Because life expectancy is always an unknown quantity, if your retirement investment return is only equal to inflation, and assuming this to be 6percent, then in 12 years' time your purchasing power will halve and in 24 years' time, quarter.

This horrible statistic is the main reason why so many pensioners struggle to make ends meet. Their inflation rate is higher than the published rate due to increases in medical aid, electricity, rates and taxes and short-term insurance.

Pensioners need to take stock of their capital and understand that they should be taking a different approach by investing in both income and growth assets, such as equities and property.

When weighing the options, the following factors need to be considered:

a) Income must be secure and certain;

b) There will be down periods whilst invested in equities;

c) Property returns can drop;

d) Interest rates can fall;

e) Dividends are tax-free.

Pensioners should put aside their fear of losing capital "on paper".

What is important is that income requirements are met by diversifying between interest income, dividends from shares and distribution from property funds.

A suitable asset mix should realise both income as well as growing capital to hedge against future inflation.

• The writer is financial financial adviser of Bryan Hirsch Colley and Associates. Phone 011-880-4888 or email bryanh@bhca.co.za