By MoneyMorning.com.au

If you’ve been following Money Morning this week, you’ll know we’ve been profiling our new project, the Albert Park Investors Guild.

Today we’d like to answer some of the questions sent in by our readers.

We did, after all, ask for your feedback and questions about our new project. Which serves to remind us, be careful what you ask for!

Q: Great! Another publication from Port Phillip Publishing. What does this one do that the rest don’t?

Bernd: Every one of Port Phillip’s investment newsletters is unique in its subject matter and advice. Each editor and analyst is an expert in their field. This includes technology, resources, small-cap, property, value investing, geopolitical analysis, family wealth, superannuation and more. Our home page gives you a more complete picture than I can do here.

The Albert Park Investors Guild ties this diverse network together. And we bring aboard the international team Dan wrote about yesterday. That’s a direct link to over 130 investment experts across the globe. To be clear, we are not providing access to every portfolio recommendation within this network. What we are providing is a connection to their combined knowledge. Our fortnightly communique boils down this trove of information and analysis into concise, actionable advice. The Guild’s own portfolios — we have three — are exclusively designed for our members.

Q: How can you possibly integrate all the different views held by your board members? Is the stock market set to boom or crash? Which is it?

Meagan: The truth is that nobody knows what’s to come. But having all these different views on hand keeps us aware of the risks and opportunities available to our members. It allows us to plan for all scenarios.

We keep an open mind — accepting that the future is unknown. This philosophy allows us to recognise the opportunities and respect the threats. You don’t need to sit out waiting for the market to crash. You can employ risk management techniques, including asset allocation strategies, position sizing and stop losses. These prevent GFC-style losses, allowing you to invest with peace of mind while still meeting your wealth building goals.

Q: What stocks should I buy when the Aussie dollar crashes?

Bernd: First, I believe you meant to ask ‘if’ the Aussie dollar crashes. No one knows what the Aussie — or any currency — will be trading for five years from now. Or in six months, for that matter. That said, the Aussie has historically fluctuated quite a bit against the US dollar. In October 2008, for example, it fell as low as 62 US cents. In July 2011, it was over US$1.09. This morning it’s up a bit from yesterday, trading at 94.39 US cents.

Export oriented companies tend to profit when their domestic currency falls, and importers tend to suffer. Assuming you’re an Australian and have most of your wealth invested domestically, if the Aussie crashes, the boat will have sailed on your best opportunities. At that point, the mainstream will quickly drive up the share prices of exporting businesses.

What you want to do is buy international stocks while the Aussie is strong. If it crashes, you can sell off some of those stocks and invest your gains back in Aussie denominated businesses on the ASX. At that stage, you’ll be getting a bargain from your US dollar, Japanese yen, or German euro investments. Of course, you don’t want to invest all of your money internationally, partly because the Aussie dollar very well might not crash. And partly for other very important reasons. But that’s a different question entirely.

Q: Isn’t diversification just one of those BS ideas they teach in school but doesn’t really work?

Meagan: There’s good reason for diversification to be taught in schools. Not only does it reduce the risk to your portfolio, but it boosts your returns and reduces the volatility of those returns.

But it’s far more than a BS academic idea. Back in 2001, investment management firm, T. Rowe Price & Associates, studied 30 years of US market returns. The market returned an average of around 12% a year.

But if you had invested 50% in the US market, 25% in foreign stocks, 20% in small cap stocks and 5% in property trusts you would have beaten the market’s return. And with far less volatility and fewer down years.

And even better returns are possible if the amounts that you hold in each type of asset are routinely adjusted. That’s why we periodically rebalance the Guild’s portfolios.

To truly reduce your risk and give yourself the best chance of success, you need to adopt a complete diversification and asset allocation strategy. This is what we refer to as the Golden Rule of investing. And it works just as well in the markets as in the classroom.

Q: Wouldn’t the easiest thing be to cancel all of my subscriptions and just buy an index fund and go to the beach?

Meagan: Well, I have heard crazier ideas. And there’s certainly nothing wrong with Aussie beaches. Buying an index fund is indeed smarter than investing everything in one stock. It’s also preferable over buying say, a forestry managed investment scheme, or even handing your money over to a CBA financial advisor.

But which index fund would you buy? How would you decide? A single index fund provides no diversification away from the index it tracks. You need to spread your money across non-correlated investment types. These are assets that move in different cycles, smoothing your returns and steadily growing your wealth. And no single broad fund tracking the ASX 300 can accomplish that.

Q: You have a gun to your head and can buy one of two stocks: BHP or CBA. Which one do you buy?

Bernd: First, let me say I grew up in semi-rural Virginia. And I attended high school in Washington DC in the 1980s, during the height of the gang turf battles fuelled by the government’s ill-conceived drug war. And my wife is a Texan. So I know a thing or two about guns. Enough, at least, to know you should keep a safe distance from your target. Putting a gun against someone’s head is practically begging for that gun to be taken away and used against you.

Now back to the question.

BHP has a market capitalisation of $208.58 billion. It’s currently trading at a price to earnings (P/E) ratio of 14.04 times. A headline in today’s Age reads, ‘BHP enjoys sales bonanza’. The article goes on to highlight that, ‘BHP confirmed on Wednesday it had smashed full-year export guidance in its flagship export iron ore division.’ This should set BHP up for full-year net earnings of more than US$14 billion.

Commonwealth Bank of Australia (CBA) has a market cap of $131.31 billion. And it’s currently trading at a P/E ratio of 16.4. Its annual profit for the past financial year is expected to be around $9 billion.

Both companies are large, stable blue chip businesses. Both are worth your consideration. And the right answer, with diversification in mind, is that you’d want to own both of them — if you had to choose. It’s not such a bad idea to spread some of your wealth between a financial titan and a mining giant. And, as I’ve taken the gun away and unloaded it before handing it back, that’s my final answer.

Q: If there’s one thing you think I should know before making my first investment in a managed fund, what would that thing be?

Meagan: Numerous studies have concluded that fund managers consistently fail to beat the index they are paid to beat.

This is not true at all times, but I haven’t heard of a fund manager who managed to consistently beat the market over the long term.

But if you are going to compare one to another, I suggest you first compare the fees they charge. This is the major factor when it comes to investment performance. The evidence is clear that higher fees do not translate into better returns. In fact, lower fee funds consistently perform better — all else being equal.

That’s not to say there aren’t opportunities to buy listed funds for less than the sum of their parts.

Bernd: One thing? Really? You’re talking about your wealth here, your hard earned savings. This is the money that will see you through your golden years. The legacy you will leave to your family. The nest egg that will determine the level of comfort and care you receive for decades after you retire. The pool of savings that decide on the type of car you drive. Or the vacations you’re able to take. Or… Well, you get my point.

One thing? Research the fees. Even a 1.5% fee will take a huge bite out of your savings over time. That’s the magic — black magic in this case — of compounded interest.

Q: Why would I bother investing in overseas stocks when Australia has great banks and is riding the back of China?

Meagan: Australia certainly does have some quality companies. Aussie banks, for example, are the most profitable of all banks in the developed world. But our market is dominated by the banks and the resource sector, placing us in a very vulnerable position. We are highly reliant on the fortunes of China. And, as I mentioned earlier, you shouldn’t bet on the future, including where the Chinese economy is headed.

Opportunities here are limited. The Australian market represents less than 2% of the world’s stocks. We need to look abroad to access the best opportunities in exciting markets that aren’t well developed in Australia — areas like techno¬logy, pharmaceuticals, engineering, software, aerospace, and the big oil companies.

In addition, with the Australian dollar trading above its long term average, investing abroad can multiply your gains if the Aussie dollar drops. Of course, it might not. Which is why you wouldn’t invest all your wealth overseas.

You might be turned off by the perceived costs and hassle of buying international stocks. But it’s really not such a bother as you may think. A number of well-known online brokers allow you to buy and sell shares on international exchanges at reasonable prices. And products like exchange trade funds (ETFs) allow you to invest in international markets through the ASX.

Q: Do you work on the same remuneration model as financial planners and receive a trailing commission on products you recommend?

Bernd: We started this new project with a very clear goal. To share the combined investment knowledge of our Australian and global network with our members. We want to help you become a better, smarter investor. We want to help you grow your wealth over time and enable you to live the life you want to live. We do not receive commissions on any of our recommendations. And we do not charge a percentage based fee on your investments. Or a performance fee, which is what many fund managers charge atop their standard fees if they actually manage to beat the index returns with your investments.

We do, of course, have a business to run and families to support. Membership in the Guild is not free, but you will find our annual fixed dues to be very reasonably priced. Less, I can add after my weekend up at Buller, than a single day ski lift ticket.

Q: This sounds like straightforward, conventional advice. Can’t I just get this from a financial planner?

Meagan: Sure, you can use a financial planner. But remember this…

Financial planners may not always be working with your interests in mind. They face conflicts of interest and many still receive commissions from placing you into certain investments.

But even those acting in good faith, and with their compensation aligned with your interests, are often woefully underqualified.

That might sound overly critical. And it may be unfair to lump them all in the same basket. But I have a personal reason for being a bit harsh. My 80-something year old grandmother had a financial planner during the GFC. He left her life savings to dwindle in a standard Aussie stock portfolio — the banks, BHP, RIO, Woolworths, etc. All the while collecting his fees, of course, leaving her with just a fraction of money she’d worked for and saved all her life.

Don’t let this happen to you. Read widely, know who to trust, and take control of your investments.

Q: Does the Guild’s portfolio strategy factor in the inevitability of rising interest rates?

Bernd: Our strategy is designed to weather all kinds of possibilities. This includes the possibility that interest rates will rise. And the possibility that they will stay low for many more years to come. Building a strategy based on the assumption that interest rates will inevitably rise leaves you open to the possibility that your strategy is based on a flawed assumption.

Thanks to everyone for sending in your questions. If your question did not get answered, feel free to write to us again at [email protected] with the subject line ‘Albert Park Investors Guild’. We’re always happy to hear from you.

Regards,

Bernd Struben and Meagan Evans
For The Daily Reckoning Australia

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By MoneyMorning.com.au