Light at the End of the Tunnel

Monday 21 September 2009, 5:16PM

 It wasn’t that long ago that the news headlines were claiming we were in for the worst economic disaster since the Great Depression. There is no doubt that the events of the last two years have shaken the foundations of most developed economies and that if it weren’t for Governments around the world pumping billions of dollars into fragile businesses things would have been much gloomier. However, it now seems with the benefit of hindsight that gloom merchants were a little over enthusiastic.

Things aren’t all that bad, and in fact there is now some light at the end of the tunnel. Economists are now predicting an imminent end to the recession. That means a return to economic growth, albeit at the low end of the scale. For investors, it is time to review portfolios.

A long term investment portfolio should be diversified between the main asset classes; that is cash, fixed interest, property and shares. While it is important to maintain that diversification, it pays to fine tune the weighting given to each of the asset classes when economic conditions change.

Many investors have had heavy weightings towards cash and fixed interest investments over the last two years while interest rates have been high but trending down and growth assets (property and shares) have been in turmoil. We are now at a stage where interest rates are probably at the bottom of their cycle and likely to increase in the medium term.

Cash is looking less attractive as an investment option, as are bonds, which could well fall in value as interest rates trend upwards again. Investors requiring income from their portfolios now have a dilemma; do they stick with conservative, income-producing assets (cash and fixed interest) at low rates of return with the risk of a drop in the value of some assets, or do they increase their exposure to growth assets where the returns are likely to be greater but where there could be continuing volatility in the short term.

A sensible way forward for most investors requiring income is to have three to five years worth of income invested in cash and fixed interest and to invest the remainder in a diversified portfolio that contains growth assets. That way, it is possible to get the best of both worlds. By the time the short term investments in cash and fixed interest have been used up to provide income, the growth assets have had sufficient time to produce a good return that can be used to top up the income funds again.

The growth potential of investing in shares has been clearly demonstrated over the last few months. Since the lowest point in March this year, US share prices as measured by the S&P500 index have increased by over 55% in value and in New Zealand the NZX50 has increased in value by over 30%.

It is not possible to identify the lowest point in the share market until well after it as passed, so it is only with hindsight that we know that March may have been the best time to invest. The best gains in shares are often had within the first year of a low point, so make the most of the light at the end of the tunnel.