QI see you still have many correspondents desperate to prove property is the only wealth creation saviour. Good luck to them.
Over and above our debt-free home, my partner and I are still young enough to carry equity risk, and we prefer equities.
So, if your correspondents think that property has just had a great year, all I know is that with one month left in this tax year our portfolio, consisting largely of diversified share investments in NZ and overseas (without any gearing), has delivered over 30 per cent post-tax in this tax year.
Yes, our portfolio lost nearly 16 per cent in value last year, but that is the only year in the last eight that this has happened. The average return, without any borrowing risk, over the eight years exceeds 10 per cent per annum.
Using your rule of 72, I believe this implies that we have doubled our original capital in this time frame. I’m happy with that.
AAnd well you might be.
Your returns are probably quite typical of a share portfolio, jumping from minus 16 per cent one year to plus 30 the next, but with a good longer-term average.
I’m pleased to see that, when you apply the Rule of 72, you use eight years of returns rather than one. One year is far too short a period to judge a share investment.
For those who don’t know, the rule of 72 gives you some really useful info on returns. It can be used two ways:
- If you know your annual return, divide it into 72 and you get roughly the number of years it takes for your investment to double — with interest, dividends, rents and so on reinvested.
If your return is 6 per cent, it will take about 12 years to double. At 4 per cent, it will take about 18 years.
In the example above, we divide 10 per cent into 72, and get about seven years. The reader is looking at an eight-year period, so his money will have a bit more than doubled in that time.
If he had been irresponsible and suggested the 30 per cent return is likely to be repeated, he would expect his return to double in about two and a half years. If only!
- If you know the number of years it has taken for your investment to double in value, divide the number of years into 72 and you get the approximate annual return.
If your investment doubled in nine years, your return is about 8 per cent a year.
The rule is only a mathematical approximation. But it works well for returns between 2 per cent and 15 per cent.
QA comment about the quote you printed from Brent Sheather in this column, which read:
“The academics reckon a 50-stock portfolio is the minimum required to get the full benefits of diversification. Picking 10 stocks for a client is in our opinion irresponsible, reckless and (if you are a trustee) liable to wind you up in court for negligence”.
I have a lot of time for Sheather, and he usually quotes his sources well. This comment was un-referenced.
I looked up Burton Malkiel’s “A Random Walk Down Wall Street”. His data seem to suggest that 15 stocks gives most of the benefit you are going to get from diversification, and by 20, any more is overkill. The same answer from Charles P. Jones in “Investments Analysis & Management”.
Getting the full benefits of diversification doesn’t actually seem to make much sense.
Sure if you want to match the market you will need 50-plus stocks, but that is why there are index funds.
Lots of successful examples of good portfolios exist with less than 50 stocks. Check Carmel Fisher’s NZ fund, around 16 stocks. Try the various NZ portfolios that NZ’s largest brokerage puts out — from 6 to 10 stocks — and they work well and and have performed well to boot. (No I don’t work for them!). No court case in sight yet.
I believe that many clients would be well served with 10 stocks, and talk of people ending up in court is simply scaremongering.
It may be his opinion, but for a lot of small investors — and it is small investors in New Zealand who tend to get done for dinner by the high fee/poor tax treatment products sold by banks and ex-life insurance salespeople — 10 stocks is a cost effective, sound portfolio.
I am assuming here that the client has some other holdings to cover the rest of the asset classes.
Despite this there would be more than a couple of brokers who hold 10 stocks or less themselves and prosper very well.
To each his/her own perhaps.
ALet’s put this in perspective. If everyone in New Zealand who owns any direct shareholdings — as opposed to share fund investments — held at least ten shares, that would be a huge step in the right direction.
The last time I saw data on this, the average Kiwi shareholder owned shares in between one and two companies.
Given that some people have wide-ranging portfolios, to get an average holding of about 1.5 shares the vast majority must own shares in just one company.
There are many reasons for this. They may have acquired the shares through an employee scheme or from a power company, insurance company or inheritance.
So what’s the problem? Generally, higher-risk investments bring in higher average returns. But if you own just one, or a few, shares, you’re taking risk that you won’t be rewarded for.
One Share Wonders are, however, often reluctant to sell their shares. They say things like, “They were free. So whatever they are worth, I figure I’m ahead. Besides, if I sell them, the money will just disappear into the household budget. While it’s still in shares, it’s long-term savings.”
My response: “Let’s say the shares are worth $500. If you were given $500 in cash, would you have bought those shares with it? Almost certainly not. So why don’t you convert the shares to cash and do whatever you WOULD have done with the money?
“Hopefully, that would be some kind of long-term saving. So have the will power to put the money, right away, into a share fund, bonds or whatever.”
Note that I didn’t include direct shareholdings as an option. Clearly, spreading $500 over lots of shares would be ridiculous. Minimum brokerage and other costs would be killers.
But if you happen to have $100,000 in a single share, or even $50,000 or $20,000, you could go for a wide range of individual shares.
How many?
Different researchers have, no doubt, come up with different optimal numbers. In all cases, though, there are diminishing returns. If you change from one share to two you gain heaps from diversification. Going from 5 to 10, you don’t gain quite as much. From 10 to 15, somewhat less, from 15 to 20, less again. And so on.
And, up against the diversification gains we need to weigh the paperwork and other hassle connected with owning lots of shares. You can hire someone to take care of that for you, but you have to pay for it.
Taking all that into account, perhaps I was hasty to criticize the readers’ 15-share portfolio in the February 14 column.
The couple had some New Zealand shares and some Australian, which lowers risk. As long as the 15 shares are also spread across a range of industries, company sizes and so on, the portfolio is probably better diversified than the vast majority.
For all that, I’m still convinced that Investment Rule Number One is to diversify.
I’m sure you’re right that lots of smaller portfolios do well. But there’ll also be lots that don’t.
QThanks for your response to my letter about the virtues of active management of a “portfolio” of one investment — a piece of land at Waipu.
I have two main comments. First, I understand that portfolio theory demonstrates that you can diversify away risk.
However, it does not take good account of the differences that good active management can make, and there is good data to show that in some markets, such as private equity, active management does make a difference. In business, focus is a virtue; thus focusing on one kind of investment may be a virtue.
Many people feel that skilful management of their single investment asset — such as the Waipu land — is a viable strategy.
You devalue the Waipu landowners’ skill in assessing the drivers of value for that locale by saying that everybody will have factored this into their valuation of the land.
Not so. This is precisely how people make money out of property; by skilful understanding of their environment and meeting their market, just as any good business person does.
Second, at the other end of the spectrum from the single active management approach is the portfolio approach to investment. You prefer a mix of index funds, property, bonds etc.
However, this is all based on assumptions — in particular that markets around the world will continue to function more or less as they have been.
Just as the global reinsurance market has changed to take account of increasingly fluctuating weather — global warming probably the culprit — and we all pay higher premiums as a result, so too are some other chickens coming home to roost.
I suggest readers do a Google search using “global oil production”, “terminal decline” and “effects”.
The evidence is pretty strong that there will be a fundamental change in the world economy in the next 5 to 10 years.
A prudent investor will then take a portfolio approach to their assumptions, perhaps basing their investment strategy on:
- a 40 per cent probability that the global economy will continue as it has been (thus using your standard approach);
- a 40 per cent probability that there will be a 10-year hiccup starting in say 5 years, as the transition from a world economy based on oil as lubricant, raw material and fuel to alternatives takes place;
- and a 20 per cent probability that the present economic system will undergo a cataclysmic collapse.
This approach is similar to the fund of funds idea where you assemble a portfolio of portfolios.
It also means that (for instance) lifestyle blocks at Waipu, where food self sufficiency is being developed, have some investment value not just based on a straight-line extrapolation of the present economic system.
Sorry, that’s a bit of a curly one, isn’t it?
AIf it’s not a straight-line extrapolation I suppose it is, indeed, a curly one.
Starting with your first point, of course good active management makes a difference, when you are personally involved in the investment.
If it’s your business or your property, or you are on the board, here’s hoping your decisions and your efforts boost value. I thought I acknowledged that.
Maybe I was rather sweeping in saying everybody would know the land was valuable because it is fairly close to Auckland, near Marsden Point and motorway extensions, and with sea views. But I don’t see how you can confidently say, “Not so.” It all seems fairly obvious to me.
And I did say, “It’s always possible, of course, that the seller was naïve. That’s one way people do really well with a single property.”
One more thing: no theory shows you can diversify away risk. Diversification only reduces risk.
As Peter Bernstein said in his fascinating book “Against the Gods — the Remarkable Story of Risk”, “diversification is not a guarantee against loss, only against losing everything at once.”
Which is why I can’t buy your assertion that “focussing on one kind of investment may be a virtue.”
On to your second point, about oil. Somebody pointed out recently that quite a few occurrences and trends of the last 100 years have been different from anything we’ve seen before: extensive air travel, computers, nuclear weapons, terrorism, on and on.
Different people have said these changes will cause world shares to boom or crash. And sometimes the markets do seem to react strongly — although nobody ever actually knows what causes market fluctuations, which are the result of actions by millions of people. But after a while the markets get back on track.
No doubt you would argue that the oil situation is more important and more worrying than these other developments. Maybe you’re right.
But, to the extent what you’re saying is embraced by mainstream thinkers, it will already be affecting share prices. Companies doing research on oil substitutes, for instance, are probably valued highly.
Perhaps I’m just a Pollyanna, but I’ve got a lot of faith in our economic system. There are potentially huge rewards to whomever solves the oil problem, so plenty of people will be working on it.
But if you haven’t got my faith, by all means stick with the land. You could do a lot worse.
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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.