Guru Speak

This may seem easy, but real investment is not that simple.

For those of you who are keen to start building an investment portfolio, one of the first things to consider is your investment objective, for example, your children's education or your retirement.

Further considerations include investment horizon, the expected period of investing to achieve a financial goal, and risk tolerance - the level of risk that you can live with.

Key investment success will depend on two important determinants - asset allocation and security selection.

Asset allocation refers to diversifying your money among various asset classes, such as bonds, stocks and real estate.

While asset allocation will help you determine the level of optimal returns that justify your acceptable risk, security selection is a tool used for choosing potential securities for your investment portfolio.

Most investors make the mistake of putting more emphasis on security selection as they believe that they can generate more returns that way.

Even if it is true for some, many researchers have confirmed that security selection can contribute only about 5 per cent in additional returns, while it has been found that asset allocation can contribute as much as 90 per cent, or more.

That's why asset allocation is so important. Asset allocation can be divided into two processes, strategic allocation and tactical allocation.

Strategic allocation considers the desired rate of return and longterm risk. Investors have to consider their return objectives versus risk tolerance, including risk constraints, such as their age and available liquidity.

Return objectives can be divided mainly into four models - preservation of capital, income, balance and growth.

Preservation of capital is the best model for conservative investors with the lowest risk tolerance and shortest investment horizon, or those who intend only to safeguard their original investment.

For preservation, the minimum acceptable return should not be lower than the inflation rate. Investment portfolios in this category, commonly known as money market funds, comprise deposits, Tbills, cash and commercial paper.

An income objective caters to those investors with a higher risk tolerance and, perhaps, longer investment horizon who are seeking a stable income, such as those retiring soon.

Ideal assets for this type of investment are longterm government bonds, investmentgrade bonds, property funds and REITs with a smaller proportion of bluechip stocks with steady dividend payments.

A balance objective is halfway between income and growth and is intended to fulfil emotional rather than financial goals. This method can create longterm profits, while also producing income for the present.

Growth is the most appropriate objective for those who have just started working, are willing to achieve profits in the long term or are willing to take higher risks. Investment portfolios in this category mainly comprise stocks and, in order to diversify risk and increase returns, other alternative assets, such as commodities.

Besides strategic allocation, tactical allocation is also important. Tactical allocation shifts your investment portfolio in alignment with prevailing economic and market conditions in order to boost yields.

For instance, if the economy is declining with high inflation, those with growth objectives should consider reducing their weighting in stocks temporarily, while putting more money in government bonds or less volatile assets.

While tactical allocation can enhance asset returns or avoid possible losses, over time your investments may diverge from your investment goals, so it is important to "rebalance" your portfolio back to your original strategic asset allocation.

For example, if your original asset allocation of stocks versus bonds was 20:80, changes in the market value of your holdings could change that ratio to, for example, 25:75.

To maintain your desired ratio of 20:80 you will need to rebalance your portfolio by buying or selling some of your holdings.

It is very important to keep reviewing your investment portfolio versus returns at least annually, and you may choose to set a trigger to let you know that rebalancing is necessary.

To generate higher returns over time, investors should be more serious about asset allocation.

Asset allocation can be very personal, and investors can do it by themselves based on the above guidelines.

If you do not have the time or do not quite understand investment fundamentals, you should consult with your financial adviser.