Highway code: investment strategies

Planning your financial life is much the same as planning a journey. Where are you starting from, where do you want to go and how will you get there? If you then add into the mix any potential problems that might arise you are more likely to reach your destination.

Ongoing process

Your financial life is not a series of separate transactions. It is a part of everything you do and you need to make informed decisions about your money.

There are many facets to life, and they change. Today’s decisions might need amending tomorrow. Most people would like a picture of what the financial future might hold, to know their money will last and to be able to pass assets on in a way that is satisfying and tax efficient.

People should not take investment risks they simply don’t need or to pay more tax than they need.

There are only three things you can do with your money: spend it, save it or share it. The important thing is how you do it and that is where planning with a view on all financial aspects can help make the most of it.

A cash-flow model of a financial lifetime has the main objective of ensuring that money never runs out, whatever happens. Scenarios like university fees, retirement and long-term care, for example, can be considered. All of this can form the basis of a strategy that aims to achieve goals, and give peace of mind. The process helps provide sound information for making important financial decisions.

An important part of building wealth is to have a sound structure to investments and to keep costs low. Buying ad hoc plans is not recommended; you need to consider whether they fit in to a proper strategy.

Investment specialists talk about ‘active’ and ‘passive’ investing. Active means that a fund manager tries to ?beat the market, while passive is ?designed to track an index. Generally passive is likely to be a cheaper method of holding assets.

Costs can have a big impact on values over the medium and long term so it makes sense to keep them low. However, if you can find a manager that consistently out-performs the market, it might be worth paying more. The difficulty is finding one. Consequently, you could end up paying out more in costs in an active fund but only achieve the same as a passive fund – or worse, even less.

Softly, softly

Many people describe themselves as ‘cautious’ investors, but what does that really mean? First, it is important to understand that ALL investments carry risk of some form. The word ‘cautious’ infers that the investor would not want to contemplate falls in value of more than a small amount.

To put this into real terms, if an investment of £10,000 was worth £9,000 in a year’s time, would that ?be cautious? What if the same investment was worth £12,000 in five years’ time? ?If inflation is running at, say, five per ?cent and an investment grows by two ?per cent, the real return is minus three per cent.
Is that cautious?

A better way is to base decisions upon a cash flow model that shows the effect of a particular strategy.

Time is an important factor when considering risk and risk reduction. An investment portfolio is the foundation of long-term wealth.

The main tool used to mitigate risk is diversification – ‘not putting all your eggs in one basket’.
Asset allocation is the process used to diversify an investment portfolio.

Asset classes include:?

• equities (shares in companies);

• bonds or fixed interest (loans to companies or governments);

• property – generally commercial property;

• cash deposits;

• commodities, art, wine, collectables; and

• other assets are available that are often derived from the usual classes.?

Not only should assets be diversified, but also holdings can also be split geographically and by size of company.

The ‘correct’ asset allocation is important as it has been shown to produce most of a portfolio’s return – as opposed to individual stock selection. There is no way of selecting exactly the right mix for any investor (unless by hindsight) but the general concept holds firm.

Assets do not always perform in the way expected; good-quality companies can fall out of favour on the markets ?for no foreseen reason. When worldwide markets fall, they often do so together. With 24-hour dealing, markets are ?always open – somewhere. This means that falls happen quickly, so timing is near impossible.

Needless to say, not much can be done to avoid a crisis, by the time you know about it, then it’s too late to take any action.

Man management

How do many investors behave? The markets are doing well – so they buy. The markets are doing poorly – so they sell.

Buy high, sell low is not a good recipe for making money, but it happens all the time. There is an old investment adage that ‘it’s not timing the market that counts, rather time in the market’.

If you wish to invest for less than five years, keep out of equities, unless you are prepared to lose a large chunk of it. You might be lucky, but should luck form part of your decision-making process?

There are only three times that values matter; when you buy, sell or die. ?At other times values are merely reflections of other people’s transactions. If you watch TV and see that the stockmarket has fallen by 20 per cent, does that make your stomach churn? ?If so, you should not have invested in ?the way you have.

A properly planned diversified portfolio of investments should give you the peace of mind to ride market storms and achieve what is needed.

Investment strategy is particularly important for trustees, as it is someone else’s money they look after. The Trustee Act 2000 is clear as to the investment responsibilities of trustees. It demands that a trustee must exercise such care and skill as is reasonable in the circumstances.

They must from time to time:?

• review the investments;

• decide whether they should be varied;

• consider the suitability of the investments to the trust; and

• assess the need for diversification.?

When reviewing the investments ?of the trust, a trustee must obtain ?and consider proper advice about whether the investments should be varied. The ramifications of not taking advice are serious, with liability falling on the trustee’s shoulders. A strategic investment review will help the trustees to ensure that they are meeting their statutory duties.

The way financial services are provided will change on 1 January 2013.

In June 2006, the FSA launched its retail distribution review (RDR), looking at how financial services are distributed to retail consumers. From January 2013 regulatory requirements will change to:?

• improve the clarity with which firms describe their services to consumers, with all firms clearly describing their services as either ‘independent advice’ or ‘restricted advice’;

• ban advisers taking commissions from product providers and replacing that with client agreed remuneration or fees; and

• increasing the level of qualifications held by advisers.?

The financial advice industry has a chequered history and the RDR is designed to bring back confidence ?to the market.

This will mean that the services being provided will be clear, the amount paid will be agreed by the client before deals are done, and advisers will have better technical knowledge.

 

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Things to think about before investing

• What proportion is the investment to the rest of your assets?

• What are you trying to achieve with your investments?

• How long can you afford to be without the money you’ve invested (most investment products should be held for at least five years, but often this could be significantly longer)?

• What do you want your investment to provide – capital growth, income or both?

• How much risk are you prepared to take?

• Are you able to bear the loss of some or all of the capital if it performs badly?

• Do you want to be consulted on investment decisions, or are you happy for the fund manager to do this for you?

• What are the tax implications – what tax will you pay and can you reduce it?

• How much does any investment under consideration cost, both now and ongoing?

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Malcolm Smith is a chartered financial planner and head of wealth planning for Chapel Court Wealth Planning Ltd

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