Investment Planning

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Why and when to invest

Investing should be to meet your own longer term goals. Your planned expenditure and some emergency cash should always be ringfenced so that investments don’t need to be accessed in the early years.

We need to establish:

  • Your future plans
  • Your timescales
  • Your attitude to investment risk
  • How much accessible cash you should retain

Investment risk

Risk and reward go hand in hand and you need to be comfortable with the level of fluctuation in capital values that might occur on your portfolio. We use various tools to assess and measure your risk tolerance and talk about it so that you appreciate the range of possible outcomes from your portfolio over time. We also consider your capacity to take risk and your need to take risk.

Risk has four primary aspects that are discussed when we sit down with you.

Risk perception generally relates to how much you know about investment markets and their tendency to follow a roller-coaster path that is not always comfortable. We tend to be more afraid of things we know very little about. Those who have a high degree of knowledge about financial markets tend to see them as less risky.

Risk tolerance expresses how you feel emotionally about taking risk. Where do you strike the balance between getting a favourable outcome versus and unfavourable outcome? Analysis suggests risk tolerance slowly decreases with age, and personality traits are known to be affected by major life events, good or bad. However, it appears that risk tolerance neither collapses in bear markets nor soars in bull markets. We see that people tend to accept risk in bull markets and avoid risk in bear markets. What we are talking about here is often linked to misunderstandings about how markets work in the long term. We use a risk profiling tool called ‘Finametrica’ that has been long established as a credible measure of how we instinctively feel about risk.

Risk required is often overlooked and relates to the returns that you need to meet your objectives. The higher the return required the more risk might have to be taken, and this need may override your perception and tolerance. On the other hand, you may choose to amend your future plans in line with your attitudes.

Risk capacity has do do with whether, for a given level of risk, your financial situation can withstand the impact of a market decline without suffering an unacceptable loss of lifestyle now or in the future.

Asset allocation

The most important decision relates to the mix and proportion of equities (shares) fixed income securities (government and corporate bonds) cash, commercial property and other assets that will be held. Academic research suggests that this process, called ‘asset allocation’ is the key to successful investing and that stock picking and trying to time the market are much less relevant in the longer run.

We believe that for investors the most important decision concerns the mix of holdings in the portfolio rather than focusing on the individual holdings themselves. To work out what is best for you we consider factors such as your financial needs and objectives, your overall resources, your attitudes to risk and for how long you want to invest.

When constructing investment portfolios we follow the principles of modern portfolio theory (MPT). This was first developed in the 1950s by Harry Markowitz. The aim is to maximise return and minimise risk over the long term by carefully choosing different assets and blending them in a portfolio.

MPT is a mathematical formulation of the concept of diversification in investing; selecting a collection of investment assets that has collectively lower risk than any individual asset. This is possible in theory because different types of assets often change in value in opposite ways. For example, when the prices in the stock market fall, the prices in the fixed income (bond) market often increase, and vice versa. A collection of both types of assets can therefore have lower overall risk than either individually.

In the short term, external events can impact on investor behaviour and market efficiency making them act and react in unpredictable ways. This is why we view investing as being for periods of not less than five years and preferably much longer. We usually advocate high cash holdings outside clients’ investment portfolios to give liquidity and the capacity to ride our market highs and lows.

Our Investment Philosophy

We believe that it is extremely difficult for anyone – including professional fund managers – to beat the market in the long term. Therefore we think it makes sense to begin by considering funds that follow an index. We build investment portfolios using a range of low cost UK and global funds to match your financial planning objectives.

Traditional investment managers strive to beat the market by attempting to predict the future. This is commonly called ‘active management’. Too often this proves costly and futile. Predictions are simply guesses and by holding the wrong stocks at the wrong time fund managers can miss the strong returns that markets provide whilst incurring the inevitable costs of regular trading. These costs are passed to the investor.

We wish to remove the uncertainty and potential for fund manager underperformance from our investment strategy and as a consequence have designed a range of portfolios aiming to achieve the principles of the Efficient Market Hypothesis (Prof Eugene F, Fama, University of Chicago).

The hypothesis states:

  • Current share prices incorporate all available information and expectations
  • Current share prices are the best approximation of intrinsic company value
  • Price changes are due to unforeseen events
  • “Mispricings” do occur but not in predictable patterns that can lead to consistent outperfomance.

The implications of this are that:

  • Active management strategies, where fund managers make choices, cannot consistently add value through share selection or market timing.
  • Passive investment strategies, where the whole market is tracked, reward investors with market returns.

Removing the services of active fund managers also removes a significant layer of expense which means that we can achieve our aim of capturing market returns at a much lower overall cost.

Passive Investment

Active fund managers continually buy and sell their holdings to meet their investment objectives. This ‘portfolio turnover’ can be significant with corresponding costs that eat into your returns. We use low charging funds that follow indices as well as similar funds that have mechanisms to focus on particular market elements thereby retaining the potential to outperform the main markets.

We build our client portfolios to suit individual risk profiles and investment objectives by choosing from the growing number of passive and ‘enhanced index tracker’ type funds. By removing the need for a fund manager we can save management costs.

An index is a group of securities designed to represent a broad market. It provides a benchmark for that market’s performance. The range of funds available is growing apace and investors can gain access to various UK and global markets. These types of fund offer:

Diversification – they can be an ideal way to achieve diversification, as they hold all (or a representative sample) of the securities in the target benchmarks.

Tilt – An enhanced tracker fund allows us to ’tilt’ portfolios to include funds with an increased exposure to smaller and value companies. Evidence shows that superior returns can be achieved from such funds over time as long as you are willing to accept increased volatility.

Low costs – as index funds track a target benchmark they generally have lower advisory fees, operating expenses and trading costs than actively managed funds.

Ease of understanding – the funds have precise objectives – to track various indices – and the charges are clearly expressed with no extra costs hidden in small print.

N.B You should remember that index and passive funds don’t lower overall market risk. When the stock market falls, the price of shares in an index fund falls too.