Saving Investments

 

Wow I can get you 20%!

OK, the above may be slightly tongue in cheek; however, how many times have you heard so called advisers use something similar in their pitch?

Being a financial planner is the best job in the world; it helps people to identify, achieve and maintain their desired lifestyle; it helps people live life to the full; it gives people clarity and confidence over where they are heading; it gives people more time, more choices, more freedom, and more life.

There is a sting in the tail to the opening of this article and that is the management of client expectations. Whilst there are occasions where achieving 20% is possible, our responsibility to clients is to manage their risk and expectations. In today’s low inflationary, low interest rate environment, consistency of returns is often a greater priority for our clients than some magic formula to potentially double their money overnight.

Your adviser will accurately assess your tolerance to volatility and then benchmark your portfolios return against inflation (CPI in this example). So whatever the inflation rate in future, in this case, the client who has a balanced approach to investing, will anticipate a net return of inflation plus 4% pa. If inflation today was 3%, they should anticipate a return of 7%; if inflation rose to 5%, the return would be 9%.

Let’s look at the following to illustrate the point on volatility:

Investment Amount £100,000             Client 1         Client 2        Client 3     Client 4

Year 1                                                          25%            -10%         20%                8.5%

Year 2                                                          -15%             -5%          20%                8.5%

Year 3                                                           30%              20%         20%               8.5%

Year 4                                                          -15%             20%          20%              8.5%

Year 5                                                            25%            20%          -30%             8.5%

TOTAL                                                           £146,758    £147,744   £145,152       £150,366

 

Or put more simply, if your investment falls by 50% in the first year, next year it has to grow by 100% (double) in order to get your investment back to the original amount.

As Albert Einstein put it: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it.”

Ask yourself the question; are you earning it or paying it? For further information, I would recommend going onto YouTube and searching for the “Power of 72.” Why is this so important? Because it is the foundation of any investment strategy; when you understand the impact inflation has on your bank deposits and charges on your investment, you will appreciate the importance of professional financial advice.

OK, so you have identified that consistency is probably a better way of investing and accumulating your wealth, so how do you do it? At this point, I’m going to shy away from Modern Portfolio Theory and Asset Allocation; suffice to say that these strategies have been used and proven for many decades and a philosophy followed by the likes of Yale and Harvard endowment funds. These multi-billion dollar funds consistently produce double digit returns whilst reducing volatility i.e. the peaks and troughs highlighted above.

The old saying “Never put all your eggs in one basket” was coined before asset allocation and the same applies to investments, but what does this mean in reality? It is irrelevant whether you prefer property, gold, commodities or shares; all of these assets have different strengths and weakness and it’s the right combination for you that is important and critically, that it is reviewed frequently to re-balance.

All asset classes are either positively or negatively correlated with each other. Now you are probably wondering what correlation means, so think of two children on a seesaw. When one goes up, the other goes down. Historically, when share prices went up, gold prices went down, as they were negatively correlated. When the US stock market fell, so generally did all stock markets around the world (to a greater or lesser extent) and this is what is meant by positive correlation. Do you get the picture?

If we look at 2013, equity markets in the developed world had a storming year with 30% + returns; however Asian equity markets didn't fare as well. Now none of us have a crystal ball or are able to predict the future, so the secret is to have exposure to all markets and asset classes in accordance with your appetite to volatility i.e. risk profile. The pie chart below represents the split between the various asset classes and proportions as an example of a truly diversified portfolio. The purpose of re-balancing is to ensure that your percentage exposure to each asset class remains consistent as it ensures your risk profile is honored.

 

About Andrew Prince:

Andrew Prince is a Financial Planner at Acuma Independent Financial Advice. With a technical background, Andrew uses his 20 years’ experience as a Financial Planner for the benefit of the client. Holding the Chartered Insurance Institutes Advanced Financial Planning qualifications, Andrew has been helping clients in the Middle East since 2010. Previously, he ran his own FSA-authorized company in the UK specializing in investments, particularly in conjunction with trusts and estate (tax) planning.

 

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