The foundations of a successful investment experience.
The purpose of investing
Investing is the process of delaying consumption from today to sometime in the future and employing that money in the meantime in the markets to grow at a rate at least in line with inflation, but preferably more. The lifestyle goals that you want your money to achieve for you need to be carefully defined. In turn, these lifestyle goals can be translated into financial goals against which your portfolio will hopefully deliver suitable mid- to longer-term returns. It is defining this sense of purpose that sits at the heart of good financial planning and which allows for the construction of a portfolio strategy that you will be able to live with both emotionally and financially. So far, so good.
As the old saying goes, however, investing is simple but not easy. This post summarises what we believe to be a sensible and highly effective way to invest your money. Investing may never be easy, but it can be far easier once you employ a systematic approach, like the one we have designed.
Investing money well requires a logical and robust framework on which to build a lifelong investment programme. It needs to be grounded in investment theory, supported by empirical evidence and enhanced with an insight into the behavioural traps and pitfalls that all investors face, that can and do cost them dear.
Building you a portfolio for all seasons
The first thing to remember is that there is no absolute best way to construct a portfolio, but there are certainly some portfolio structures that are more sensible and more robust than others.
One of the biggest challenges that all investors face is deciding what asset classes to invest in and what to avoid. The spectrum of choice is wide, from cash and UK equities, through to fine wines and Ecuadorian rainforest. We base our choices on each asset class’ ability to meet our pre-determined selection criteria. The discipline of this framework allows us to review any asset class or investment strategy that crosses our desks in a systematic way. Having to analyse it against our criteria, forces us to engage our reflective mind, which defuses much of the emotion that might exist. Being entirely comfortable with the assets held in your portfolios ensures that when markets get tough, as they will from time to time, you are better placed to remain disciplined and stick with the strategic decisions that were made in calmer waters.
Finding the balance between growth assets and defensive assets that is most suitable for you is one of the most important decisions that we will make together. There are three distinct areas that need to be understood and addressed: first, we need to understand your emotional tolerance for taking on investment risk being the point at which you feel most comfortable, when balancing the trade-off between risk and return; second, we need to understand the worst magnitude of any falls in the value of your portfolio that you can survive financially; and finally, we need to establish how much risk you actually need to take in order to achieve your goals.
Defining the right level of risk to take is not simply the prescriptive output of the tools we use (cash flow modelling and psychometric risk profiling) but requires careful discussion, and the resolution of the trade-offs that you may need to make. This ensures that you end up owning a portfolio that has a good chance of delivering on your unique emotional and financial objectives.
We like to talk about the way we invest as being systematic. What we mean is that we do things according to a disciplined system that is efficient, methodical and objective. Low cost – which also means low activity – is key. This approach is sometimes referred to as passive investing or index tracking. Logic and evidence drive us toward a systematic approach.
The opposite of a systematic approach is a judgemental approach, which can be described as where a fund manager has the ability to act according to their own discretion or judgment to make subjective forecasts of short-term market or security prices in order to try to beat the return delivered by the market. This is often referred to as active investing.
We hold a deep conviction that in selecting well-managed, low-cost, systematically managed funds, we will be providing you with the best chance of capturing the bulk of the market returns that are on offer, which is a worthy goal. Trying to identify judgemental managers, who can persistently overcome their fees and costs to deliver market beating returns is extremely difficult and requires long track records to discern skill from luck. Picking funds that will even be around is a tough starting point, given the poor survivorship record of the industry. Living with the inevitable underperformance that will occur from time to time when employing judgemental fund managers is not for the faint hearted and may well lead to impatience and ill-discipline; and we know where that leads.
We are confident that our approach will provide you with every chance of having a successful investment experience. We cannot guarantee what returns the markets will deliver in the future, but we can guarantee that you will capture most of what is available through our systematically managed, best-in-class funds. By owning a well-diversified portfolio for all seasons, having faith in capitalism, allowing the markets to do the heavy lifting, being patient and remaining disciplined, you give yourself – with our continued help and guidance – every chance of success.
If you have any questions please contact me and we can arrange a time to talk.