We’ve all heard the stories about “a friend’s father-in-law” or “Bill down the pub” who had a tip about the “next big thing” in the stock market and invested their life savings into it. This is usually where the conversation turns one of two ways – “It was great, I doubled my money in just one year!” or more commonly “I mean, it is down by 30% at the moment, but I’m sure it will come good soon.”
To most of us this attempt to “outsmart the market” seems like a very daunting prospect and only a few steps away from simply gambling, which is certainly not something we would advise when planning for your future! I believe that this is could be part of the reason that a lot of people don’t ever make the most of investments for long term savings goals. As discussed in my latest blog, investments don’t need to be as harsh or sudden as this. With a regular payment into a well-balanced investment plan there is opportunity to obtain meaningful long-term growth even whilst maintaining a cautious approach.
When investing, it’s important not to latch onto the “next big thing” that’s happening in the market – putting all your eggs into one basket in this way, without any planning, could be a recipe for disaster. For example, what if the company whose shares you have invested your life savings in, suddenly goes into liquidation. You may lose the entire value of your investment, leaving you with nothing.
Rather than placing your money into one investment, it’s key to spread them across various different industries, geographical regions and asset types such as property, equities as well as both corporate and government bonds. This is what is known by the investors as “diversification” and is vital to any well thought through investment portfolio.
When we work with our clients we want to help them understand the importance of diversification from the outset, as having this understanding at the beginning of the investment process means that they have greater insight into what kind of investments are going to be most suitable for their situation and objectives. It is also important for clients to remain focused on the reason for having the investment in the first place, for example pensions for retirement or purchasing a second property abroad, as this will partially determine what sort of mix of investments will be appropriate. Through the understanding of diversification and by focusing on the end goal, we are able to remove the emotions of fear and greed that are the downfall of many casual investors.
An individual’s investment portfolio should be constructed around their attitude towards investment risk and their capacity for loss (i.e. what impact would a loss have on their overall situation), and these elements always form the cornerstone of any investment recommendations we make. Typically, the lower attitude to risk and capacity for loss, the greater the spread of asset classes and lower proportion of high risk equities required within a portfolio.
It is also worth noting that some investments are negatively correlated, meaning that when one falls in value, another can go up; so having your interests spread more widely allows you to take advantage of this relationship between asset types. Although this approach could dampen returns, it also helps reduce the amount you could lose and lessens the uncertainty that comes with investing.
Let’s take a look at a practical example of how diversification (or lack of) can have a significant impact on a client’s objectives:
Dave is a 55-year-old business owner who is looking to retire in the next five years. He’s decided to invest nearly all of his savings into an oil company’s shares to try and benefit from a predicted boom in oil prices. However, this money represents the only savings Dave has towards his retirement goal and the more risk he takes in the hunt for greater returns, the higher the likelihood that his portfolio will experience significant falls in value over the short term due to market fluctuations. If the oil price falls unexpectedly, or if the company Dave invests in collapses, this could place his entire retirement plan in jeopardy, meaning he may have to continue working longer than initially hoped.
A more balanced approach, investing across various geographical regions and asset classes, may well have limited the growth Dave could have achieved over the next five years, but it would also have protected his portfolio value from excessive losses, so he would still be able to retire as initially planned.
Our team at Cameron Chase work closely with our clients to better understand the most appropriate approach to investing, and part of this is looking closely at the individual’s risk profile in the wider context of their overall financial objectives. If you’re interested in learning more about our approach to investments then feel free to get in touch.