Designing the perfect investment portfolio

Many (maybe most) investors are looking for the perfect investment portfolio – the ideal mix of investment assets that will lead to outsized gains, and low volatility, over an extended timeframe.

There are many, many factors to consider in designing an investment portfolio, and an almost infinite set of criteria that can be applied.  A by no means definitive list of options could include: stocks v fixed interest v property v cash, passive v active management, developed v emerging markets, NZ v Australia v international, currency hedged v unhedged, short term bonds v long term bonds v term deposits, commercial v residential property, value v growth, high v low volatility, momentum v contrarian, etc, etc.

Unfortunately, building the perfect portfolio is only possible in retrospect.  There simply is no way to definitively know what particular mix of investments will be best going forwards.

That said, I do have some recommendations for designing an investment portfolio:

  • Define your investment goals. What do your investments need to deliver to meet your goals?  Are your investment goals compatible with your risk profile (see next point)?
  • Set the right risk tolerance. This is the degree to which you can stand ups and downs.  Ups are all good, but can you cope with your portfolio losing 30% in one year?  This is a financial capability question and an emotional tolerance question.  If you can’t cope, either financially or emotionally, design a less risky portfolio (as long as it still meets your investment goals).
  • Match your asset allocation to your investment goals and risk tolerance. If you really couldn’t cope with a 30% fall in the value of your investments, don’t invest everything into shares or property (as an example).  A financial adviser can help with this.
  • Keep things simple. This is easy.  If you don’t understand how an investment works, don’t invest in it.
  • Diversify. Diversification is one of the few “free lunches” available to investors.  A well diversified portfolio (a large spread of investments) can achieve the same expected returns as a less diversified portfolio, but with lower volatility.  It’s a theoretical advantage worth having.
  • Rebalance. Your ideal portfolio may be 50% shares and 50% fixed interest.  If your actual mix strays significantly from this (say more than 15-20%), it’s time to rebalance back to your ideal mix by selling some assets and buying others.  This is a disciplined way of selling high and buying low and works when markets are rising or falling.
  • Sick with it, and be patient. Maintain your portfolio mix for years, and maybe even for decades.  It’s easy to get excited by the latest fad – crypto currencies, tech stocks, Auckland real estate, whatever.  But don’t get sucked into chasing returns by “skating to where the puck was”.  This will usually be counter-productive.

It’s highly likely that your investment portfolio won’t turn out to be the optimal portfolio – there will always be portfolios that will do better (higher returns, less volatility) – but you won’t know which ones until after the fact!  However, if you do stick with the above guidelines, you will be giving yourself a very good chance to be successful and to meet your financial goals.


Dean Edwards

Term deposits: what if you need your money in a hurry?

Despite bank interest rates for savings being at historically low levels, term deposits remain popular investments for the defensive part of an investment portfolio.  I also support the use of term deposits; in the current environment of low, but gradually rising, interest rates, they are often a better alternative than bonds, where there is a real risk of capital losses if interest rates do rise (note the opposite applies in times of declining interest rates).

But sometimes life comes along and interrupts the best laid plans, and you need access to your term deposit money in a hurry.  What happens?

Usually banks will allow you to break term deposits.  However, the rules applied around these breakages vary significantly from bank to bank.

In a recent example, a client with similar term deposits held at both ANZ and RaboDirect needed to get cash in a hurry to settle a house purchase.   For RaboDirect, the term deposit could be broken immediately, with funds available that day, no loss of accrued interest, and no other costs incurred.  However for ANZ, there was a 30 day notification period to break the term deposit, and a loss of interest of 3% for the portion of the term deposit broken – which would be charged back if the interest had already been paid out.

These are significantly different treatments between banks of essentially the same situation.

The moral of this story is when making term deposit investments, understand the bank’s policy if you need to break the term deposit for any reason.  There are other factors to consider with term deposits than just the headline interest rate.


Dean Edwards


PS.  This is not a recommendation for RaboDirect over ANZ (or any other bank) for term deposits.  For RaboDirect, breaking term deposits can sometimes result in penalty charges – it depends on the term, current interest rates, and historical interest rates.  The point is that this is important knowledge to be armed with when making term deposit decisions.


2017 – a stellar year

Well, 2017 was, broadly speaking, a stellar year for investment markets – local and global, developed and emerging.

As a relatively new business, I have set up a benchmark portfolio, which I track and report on regularly.  While this portfolio will not match any client’s portfolio exactly, it does provide an indication of how the Nest Egg Investments investment approach plays out in real life.

The benchmark portfolio falls into the growth category of portfolios (typically suitable for investors with a timeframe of 8+ years), and consists of:

65% growth assets:

  • Australasian shares 19%
  • Global shares 33%
  • Emerging markets shares 6%
  • Commercial property 7%

35% defensive assets:

  • NZ fixed interest 15%
  • Global fixed interest 15%
  • Cash 5%

Within the above allocations are a mix of passive funds (very low fees, track an index), structured passive funds (similar, but overweight in particular attributes, eg. value stocks or small cap stocks), and carefully chosen actively managed funds.  There are 9 funds used in total, plus term deposits for NZ fixed interest, plus cash.

The results for calendar year 2017, in NZ$, after all fees (fund manager fees, platform fees, adviser fees) but before tax, are as follows:

  • Australasian shares: +24.6%
  • Global shares: +22.2%
  • Emerging markets shares: +28.5%
  • Commercial property: +11.8%
  • NZ fixed interest: +3.3%
  • Global fixed interest: +3.8%
  • Cash: +0.9%
  • Overall portfolio: +16.4%

Equity markets all around the world performed strongly in 2017, and this was the big driver of the strong performance overall.  Interestingly, of the 3 top performing funds in the benchmark portfolio (after fees), 2 were active, one was passive – I generally like and often recommend having a mix of investment styles within a portfolio.

Going forwards, I won’t try to predict how markets will perform.  But a small word of caution … watch out for recency bias, where you compare what happens next based on the very recent past.  2017 was great, enjoy the fruits of excellent returns, but reset your expectations going forward.  Investment markets go up and down – often quite wildly!  Let’s see what unfolds in 2018.


Dean Edwards

To hedge or not to hedge?

That is the question.

What am I talking about?  I’m talking about whether or not the offshore investment assets you hold should be insured (or hedged) against a rise in the value of the New Zealand dollar.  Your hedging strategy can make a significant difference to your investment returns.

In an unhedged example, say you hold a US investment worth US$100 dollars which over a year goes up in value by 10% to US$110.  But at the same time, the NZ dollar v the US dollar also appreciates by 10%.  Your effective return in New Zealand dollar terms is zero!  In other words the negative change in currency has offset the growth in your investment. 

Of course it can go the other way too.  In the same example, if the value of the New Zealand dollar depreciates against the US dollar by 10%, then the effective return in New Zealand dollar terms is 20% (10% investment return + 10% currency return)!

In other words, changes in currency can help or hinder the overall returns from your offshore investments, depending on which way the NZ dollar moves v the currency of the offshore investment.

Hedging effectively removes the currency ups and downs by having insurance in place (often via futures contracts) that can be exercised if the New Zealand dollar does indeed increase in value.  This effectively takes currency movements out of the equation, so that the returns you get in New Zealand dollar terms are the same as the returns from the investment in its local currency.

Hedging does have a cost.  For example, the popular Vanguard International Shares Select Exclusions fund offers a hedged and unhedged option for NZ investors, with management fees of 0.26% and 0.20% respectively.  The difference in fee is entirely due to the costs of currency hedging. 

So should you aim to have your international investments hedged or not?  Opinion in the financial world is divided, but I won’t sit on the fence.  For international fixed interest investments, yes.  For international equity or property investments, no.  


For international fixed interest investments (eg bonds/bond funds), these fall into the defensive part of a portfolio – they are there to provide a steady return with low levels of volatility.  You are defeating the defensive purpose of these investments if you layer on currency exposure, and potentially ramping up the volatility significantly.

For international shares and property, I prefer unhedged investments.  For a start, you save on the cost of the hedging.  Also, in my experience, falls in overseas markets often go hand in hand with a fall in the New Zealand dollar – which helps to offset the negative investment returns.  Likewise nasty unexpected geo political events often can see a flight to safe haven currencies (like the US dollar) and a fall in the New Zealand dollar.  These movements help the value of your international assets in New Zealand dollar terms. 

But the currency factor can, and at times will, go against you.  But overall I’m comfortable with accepting a currency risk in the growth area of a portfolio (shares and property).

Finally, when you are looking at NZ$ returns from international investment assets, its always worth asking what proportion of the returns are due to investment performance, and what proportion are due to currency movements (I split this out in performance reports for my managed clients).


Dean Edwards


Active v Passive – which is better?

There is huge debate within investment circles as to what is the best long term strategy for superior returns: an active strategy, where an investment manager picks securities which s/he hopes will outperform the market, or a passive strategy which effectively invests in the whole market, and returns are aligned to the market overall.

Passive strategies are generally cheaper (lower fees), as they are programmatically driven – a passive fund will own exactly the same securities (and in the same proportions) as the overall market that it tracks.  There are no investment decisions required, other than to buy or sell to match the market over time.

Active strategies however employ an investment manager, and often researchers too, so the costs are higher, reflected in higher fees.  Decisions on what to hold and when to buy and sell are at the discretion of the investment manager.  Returns might be very different from overall market returns.

Which strategy is better?

There is a significant body of research that suggests that for large developed markets, most (but certainly not all) active fund managers struggle to beat the market consistently after fees. 

Why is that the case?  Well one of the explanations is that there are always a small number of “winners” in markets – stocks that will increase in value massively in a short time period, and in so doing, help to raise the performance of the market overall.  However, in markets with literally thousands of stocks (think North America or Europe), identifying the winners is very, very difficult.  Active managers effectively try to do this, but often do not succeed.  Or if they get it right one year, they may not get it right the next year.

Passive funds however, because they invest in the entire market, always get the “rising tide” benefit of owning some of the winning stocks.  Over time, this seems to give passive funds an edge over most actively managed funds, especially when fees are also taken into account.

But what about smaller markets like New Zealand (and Australia to a lesser extent)? 

Because of the smaller overall size of the market, I contend that it is far easier for good investment managers to identify the winners, and also to avoid the losers.  This is one of the reasons why I prefer an active management strategy for NZ (and to a lesser extent Australia) equities.  The other reason is that the fees for NZ passive funds are very high compared with equivalent international passive funds (eg. NZ SmartShares fees are ~0.5%), so the fee advantage for passive funds is diminished.

To back up my assertion, I have been monitoring the performance of two of my preferred actively managed NZ/Aus funds, compared to investing in a 50/50 mix of available NZ/Aus passive index tracking funds.  So far, after fees, the actively managed funds are outperforming the index tracking funds by healthy margins for 1 year, 3 years and 5 years (as far back as my data goes) – they are more than 30% ahead of the passive fund mix in each category. 

The scale of my research isn’t big (its unlikely to be featured in any investment white papers!)  And I am only looking at two of my preferred active funds, not all active funds.  But it does highlight that there are nuances to the active v passive debate: the size of the market is important, and the level of fees charged (especially for the passive funds) also matters. 


Dean Edwards


International shares – not always taxed the same

For most investors, owning a healthy allocation of international shares is a wise investment decision.  Offshore markets provide access to sectors not well represented in the NZ market (technology and pharmaceutical companies are good examples), offer geographic diversity, and exposure to high growth economies (particularly via emerging markets).

Owning international shares is usually via investment funds – NZ based or overseas based – or could be via direct holdings in international companies (which in terms of this blog post, are treated in the same way as overseas based investment funds).

Interestingly and worryingly, international investments are taxed differently depending on whether the investment is with a NZ based provider (many KiwiSaver funds would be good examples of this), or with an overseas based foreign investment fund – also known as a FIF.    

With a NZ based fund the international holdings are taxed via a mechanism called the Fair Dividend Rate (FDR).  Under FDR, you pay tax on 5% of the value of your international shares at the start of that tax year.  This is regardless of whether your international shares have increased or decreased in value over the course of the tax year.  Why is there an FDR regime at all?  It was introduced to account for the fact that international companies tend to reinvest their profits more than NZ companies (which pay more taxable dividends). 

FDR is a swings and roundabouts approach.  Say your international shares increase by 20% in one year – under FDR you will still only pay tax on 5% of the start of year value … nice!  But if your international shares decrease by 20% in a year, you will still pay tax on 5% of the start of year value … ouch!

However, things are different if you are invested internationally via a FIF (Foreign Investment Fund).   Rules for FIFs give you two options for paying tax.  Either the FDR approach described above, or you can use the Comparative Value approach that compares the value of your shares at the start and end of the tax year, and you pay tax on the difference.  Under FIF rules you get to choose which tax method (FDR or Comparative Value) is most beneficial – ie results in the least tax payable.  In negative years, where the value of your international shares has fallen, under FIF you can choose the Comparative Value method for that year, and effectively pay no tax.

So … if you managed to follow the above, you will see foreign funds have a distinct tax advantage over NZ based funds in years where the value of the international shares declines (in fact the advantage is present for year on year declines, and for gains of up to 5%). 

This different tax treatment is sub-optimal, and unfair for NZ based funds.  But until this situation changes, from a tax perspective only, it is preferable to hold international shares via foreign-based funds (or direct investments in overseas companies). 

Of course, there are other considerations beyond tax.  For example most NZ based funds will calculate and pay the tax on international holdings on your behalf, versus possibly having to work it out yourself for foreign investment funds.  And many NZ based funds will hedge their international holdings against currency movements (which can be either advantageous or disadvantageous, depending on whether the NZ$ rises or falls).


Dean Edwards


PS.  Tax of course is nothing if not complex.  There are a few nuances which I haven’t included here as I want to keep this blog post readable!  If in doubt, please consult a tax specialist.


Enjoy the fruits of your labour

There are undoubtedly some challenges from transitioning from working for a living to being retired.  The challenge most often highlighted is how an individual deals with moving from (usually) paid employment which comes with a busy work day, deadlines and pressures, teamwork and social interaction with colleagues, a sense of accomplishment, and of course a salary; to a retired lifestyle with less structure and predictability, more free time, different social interactions (perhaps much more time with your spouse!), and of course no more salary!  The journey involves a lot of change –  sometimes sudden change – and can be a difficult path for some retirees.

There is another challenge I come across quite often amongst the newly retired – the psychological hurdle of switching from saving to spending. 

There are many people who have saved very hard over their working lives to build up a substantial nest egg to support their retirement.  But flicking the switch to suddenly go from saving their money to spending their money once they have retired runs against the habits of a lifetime!

I see a number of people who live with a level of unnecessary deprivation in retirement.  They have accumulated enough investment assets to enjoy a very comfortable standard of living, but often needlessly restrict their spending and “go without”.  Sometimes this is down to not having a good understanding of how much they can safely spend during their retired years without running out of money.  But it’s also often related to deep down being uncomfortable with depleting their retirement nest egg, which they have worked so hard to build up.

The solution is to firstly work out what a safe level of spending is for you in retirement, and then very consciously talk about and agree the level of spending you wish to have, and the implications of that – including what it means for your savings over time.  Once you have got your head around the fact that your retirement savings are indeed there to fund your retirement, it can be surprisingly liberating!  You may not need to put off that overseas holiday or new car.  You’ve worked hard your whole life to be in a good position when you retire – now is the time to enjoy the fruits of your labour!


Dean Edwards


Spending in retirement

How much do retirees in New Zealand actually spend, and on what?

Dr Claire Matthews from Massey University publishes the Retirement Expenditure Guidelines, now in its 4th iteration.  The Retirement Expenditure Guidelines surveys actual spending by retired households in New Zealand and provides a wealth of interesting data.

Some of the findings include:

  • NZ Super on its own is not sufficient to sustain even a no-frills level of retirement spending, unless you are a 2 person household living in a metropolitan area of New Zealand (and assuming you own your own house).
  • For an individual retiree living in a metropolitan area of New Zealand, savings of about $102k will be needed by age 65 to supplement NZ Super to fund a very basic “no frills” retirement.

But this is indeed a bare-bones existence.  Most (if not all) of the clients I talk with aspire to a significantly higher standard of living in retirement.  Helpfully, the Retirement Expenditure Guidelines describes a “choices” level of retirement expenditure – think better food, eating out from time to time, occasional holidays, etc.  To fund a “choices” retirement, savings to supplement NZ Super at age 65 will need to be:

  • $360k-$390k for one person households
  • $400k-$490k for two person households

The range reflects differences between provincial (more expensive) and metropolitan areas, and also assumes you own your house.

Another interesting data point to emerge is exactly where retirees spend their money.  The weekly spending for a 2 person “choices” household in a metro area looks like this:

Category $/week Percentage
Recreation & Culture  $141 13%
Food  $125 11%
Insurance  $93 8%
Home ownership  $78 7%
Miscellaneous  $76 7%
Other housing  $73 7%
Healthcare  $73 7%
Rates  $64 6%
Private transport  $64 6%
Eating out  $52 5%
Energy  $48 4%
House contents & services  $44 4%
Drinks & cigarettes  $41 4%
Telecommunications  $33 3%
Clothing  $32 3%
Vehicle purchase  $30 3%
Public transport  $29 3%
TOTAL  $1,096 100%

Understanding much you spend, and where, is a really valuable exercise for planning your retirement.  Its well worth categorising all of your spending every month, for at least 6 months, to get a handle on where your money is going.  It’s not as painful as it seems – there are lots of online tools and apps that can semi-automate the categorisation process.

Knowing what you spend on food, drinks, eating out, holidays, clothes, education, mortgages, etc is quite enlightening.  The outcomes might surprise or even shock you!  It also helps to break down necessities v luxuries, spending on yourselves v children, etc, and is vital information for working out what is a realistic level of expenditure for you when you do retire.


Dean Edwards


PS. The Retirement Expenditure Guidelines 2016 can be found here.


Investment Outlook

We’re roughly half way through the year (how did that happen so fast?), and the shortest day is now behind us.  What is the latest outlook for investment markets?

New Zealand cash and fixed interest

Most economic forecasters anticipate long term interest rates will gradually edge higher, with the NZIER forecaster poll predicting 10 year government bond yields will average 3.4% during the year to March 2018, up from 2.8% the year before.  Fixed interest investors can anticipate gradual increases in term deposit rates, but bond investors should be wary.

Opinions on the NZ dollar are mixed, although a majority of forecasters are expecting some modest depreciation.  Based on this, a small boost to investors’ returns from unhedged overseas assets looks more likely than not.

International fixed interest

While the pace and magnitude of global interest rate hikes may be less than was forecast a year ago (which has led to global bonds performing reasonably well over the last 12 months), they are still likely to happen as inflation reappears.  Interest rate increases typically equate to a capital loss for bonds, hence the outlook is negative.

NZ commercial property

The backdrop for commercial property is generally favourable.  Strong population growth, a buoyant economy, and growth in the numbers of office workers should see demand for office space (especially in Auckland) stay high, and vacancy rates low.  Commercial property provides dividend yields of around 5% at present, although gradually rising interest rates may offer an alternative for yield-seeking investors.  Outlook: positive returns, but likely underperformance v the wider share market.

Australian & international property

In Australia, retailers have been struggling (some closing their doors) in the face of increasing online competition, including the upcoming arrival of Amazon.  This however has boosted the demand for warehousing, storage and logistics properties.  With similar headwinds from rising interest rates, underperformance v equities is likely.

Rising interest rates are likely to be an even bigger hurdle for global commercial property, where the global property index yields only 3.7%.  The outlook here is for underperformance.

NZ equities

The NZ economy is full steam ahead.  Commodity prices have increased across the board, businesses are generally upbeat about their prospects, and prepared to hire and invest.  Expectations for profits (which were already high by historic standards) have risen further.  NZ equities are expensive (19.9 times projected earnings), but can continue to perform well on the back of the strong economic conditions.  The outlook is for further strong performance.

Australia equities

In Australia, economic growth has been more muted, although recent signs of a pick-up in activity are encouraging.  While Australian shares are less expensive (15.3 x prospective earnings), the consensus is there will need to be more evidence of stronger economic growth before we see anything other than modest equities performance.  Outlook = treading water.

International equities

Equities have been performing well in Europe with generally increasing economic growth and no major political shocks in recent elections (although UK shares have stalled with the minority government election outcome).  The US has also performed well year to date, increasing over 8%.  Lower than expected GDP growth has held Japan back (4% increase YTD), but emerging markets have continued to outperform the developed world, up 16% YTD.

The World Bank and OECD are forecasting the word economy to grow strongly at around 3.5% this year, with China and India at the forefront.  This strong forecast growth supports expectations for global profit growth, and does support high valuations.  The consensus view is that global equities will continue to grind out further solid gains over the next 12 months.


Dean Edwards


Generating income in retirement

One of the biggest challenges faced by the newly-retired is how to generate a regular income stream from their investment assets, and to make sure the money lasts as long as they do!

There are of course many ways to get cash from your investments.  For example, cash can come from dividends or interest payments, or from selling some shares or bonds. However, dividend or interest payments may be only once or twice a year, or if partially selling, what to sell?  Then there are the unknowns, like how long will I live for (and need money), what if interest rates fall, what if the sharemarket crashes?

All up, its complicated.

Overseas, annuity products are a popular way to get around some of these issues.  Essentially, with an annuity, you buy a regularly-recurring income stream, which usually lasts for as long as you live.  There are two great benefits with annuities: (1) frequent, regular cash payments and (2) certainty – you will keep getting paid until you die, regardless of how long you live.

In New Zealand, annuity offerings have been few and far between.  However, the Lifetime Income Fund, launched in 2015 is a promising, relatively new product which does provide a lifetime annuity.  In essence, you invest upfront into a managed investment fund, and you receive a fixed fortnightly or monthly cash payment for the remainder of your life.  Your original investment, plus investment proceeds, less fees, is drawn down until it reaches $0, but your regular cash payments will continue even after your investment balance runs out, paid for by an insurance policy (which you pay fees to fund).  If you die before your investment balance is fully depleted, the remainder will be returned to your estate.

An example provided is an initial investment of $100,000 at age 65 will return $5,000 per year (5%) for the rest of your life.

This type of product provides the certainty of fixed, regular payments, and removes the risk of outliving your income, plus the risks of market crashes or interest rate falls.  However, there are still risks, one being that this is a young product, and if there is insufficient demand, or if it proves unviable, you will not get the benefit of the lifetime payments (although you will receive back the balance of your investment, less payments made and fees incurred).

Its great to see this sort of product available in New Zealand, and I hope we may see more annuity-type offerings to follow.

Link to Lifetime Retirement Income website.


Dean Edwards


Please note that Nest Egg Investments is fully independent and does not receive commission or payments of any sort from any product providers.