Asset Allocation Strategy 2: Trevor and Vanessa

Trevor is 34 years old and married. He is a qualified engineer and has been moving through the ranks in the engineering firm he is employed at. His wife Vanessa, also 34 years old, is a successful fitness instructor with a home studio from which she conducts sessions. As a couple they currently have a stable financial situation. Trevor’s position in the firm is quite secure while Vanessa has built up a loyal client base.

They have decided to reassess their financial goals in light of their recently born child. They now want to save for the child’s education to help subsidize the cost. They both plan to maintain their contributions to their retirement savings, but decide to use Vanessa’s income for household expenses. Any expenses that exceed her income will be drawn from their joint investment account.

Trevor will be responsible for contributing to the child’s education fund with his disposable income. They expect this situation to last for 5 years. During these 5 years they decide that Vanessa will maintain her current client base but hold off growing her business. After 5 years, it is assumed the child will go into preschool and Vanessa will have more time to grow her business.

The following summarizes their situation:

  • Trevor earns an annual salary of R720 000 or R60 000 a month.

  • After taxes and other expenses Trevor is left with R120 000 disposable income a year or R10 000 a month to put towards the child’s education.

  • Vanessa earns approximately R25 000 a month on average and after taxes, insurance and retirement contributions etc is expected to cover household expenses exactly (for simplicity).

  • Their joint investment account is currently valued at approximately R1 000 000 and is invested in a portfolio of 75% equity and 25% fixed income.

Since Trevor is good with numbers and Vanessa is good with handling money from running her own business, they make a good team. They first consider whether they should have the same allocation for both their joint investment and the education fund.

After discussing it for a while they realize that these two portfolios have different goals. Their joint investment is meant to provide a cushion for unforeseen expenses. While the education fund is meant to subsidize their child’s education.

They discuss the important factors the joint account should achieve and determine the following:

  • Since the account will be used to pay for excess household expenses it should keep inflation in mind

  • There is an element of uncertainty as to when money will be needed from the account

  • The assumed investment horizon is 5 years until the child is independent enough to go to preschool and the couple can reassess how they can use their respective cash flows

With this in mind they determine that they will need exposure to inflation protected assets, assets that offer more certain returns as well as assets that have a capital gain element appropriate to a 5 year investment horizon. After educating themselves by reading through the various material on this website they determine the appropriate allocation as follows:

  • 60% into fixed income as follows:

    • 60% in a passive inflation linked bond ETF

    • 40% in an actively managed bond unit trust

  • 40% equity as follows:

    • 100% in an actively managed equity unit trust with a recommended investment horizon of 5 years

Their thinking for the allocation is as follows:

  • They are using a passively managed inflation linked bond ETF because they believe it is the simplest way to achieve the inflation targeting aspect of the portfolio. An ETF also offers good liquidity for an asset class that generally exhibits relatively lower liquidity.

  • They are using an actively managed bond unit trust because they believe that a professional asset manager has superior insight into the fixed income asset class. A unit trust also offers good liquidity in much the same way as an ETF.

  • Their equity allocation is based on the fact that the actively managed unit trust has the same investment horizon as they do. They believe that their goals are aligned with the mandate of the unit trust.

They now turn their attention to the allocation of their child’s education fund. They agree that this allocation needs to be relatively aggressive during the first 5 years after which time the allocation can be reassessed. They agree that a classic allocation of 60% equity and 40% fixed income should be appropriate.

However, they choose to use an actively managed balanced unit trust to achieve their goals. The fund fact sheet for this balanced unit trust states that the recommended investment horizon is between 3 and 5 years or longer. The unit trust can invest in equity within a range of 40% and 75% with the remainder being spread across various other asset classes. The unit trust also has an offshore component of a maximum of 30%.

The reason they chose to use a single actively managed balanced unit trust is as follows:

  • The recommended investment horizon for the unit trust is aligned with their investment horizon with an appropriately aggressive asset allocation mandate.

  • They understand how important diversification is and this unit trust is diversified across asset classes and also invests offshore outside their country of residence, further increasing the level of diversification.

  • Since this fund is essentially starting from scratch and has an important job to do once the child enters school, the fact that their money is being professionally managed brings them peace of mind.

Next: Asset Allocation Strategy 3: Nigel

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