Doing things right!

A big thank you to Sylvia my client of over 20 years for my Bouquet, Chocolates, & Bubbly – I always aim to get things right and it made me ecstatic to receive this wonderful surprise.

On 2nd July we were joined by my Personal Assistant Leanne from Timeetc to ensure that callers get a more active service. The telephone reception service from Moneypenny has been excellent but it was limited to taking and passing on messages. Leanne will be able to follow up and help you on the spot and either answer your queries herself or go straight to the person who can. Timeetc was formed in 2006 and has Richard Branson’s former PA, Penni Pike as one of its members. You may like to take a look at their website at www.timeetc.com.

One of Leanne’s first tasks was to improve our email communication and take over this job from ClientsFirst who have provided our E-Newsletter for the last year or so. This newsletter is her first and I think that she has done an excellent job – your feedback will be very welcome.

The Financial Services Authority (The FSA) is in the process of being split into The Prudential Regulation Authority (The PRA) and The Financial Conduct Authority (The FCA). They are already starting to operate separately and it was interesting to meet them on 5th July for their Business Risk Awareness Workshop. I am seeing them again on 18th July for two workshops “Attitude to Risk” and “Advice Process”. The actual date of the change is said to be early 2013 which will be after the implementation of the RDR on 1st January. The FSA has certainly had its fair share of news over the last year or so – in 2013 the RDR and FSA acronyms will become history and we will start getting used to The FCA!

This month my continuing discussion of the “The 7 Secrets of Money” is about investment behaviour: ‘The 7 Secrets of Money’ is a book that I strongly recommend: you can get your own copy from Amazon and for more information you could look at the authors’ website at www.7secretsofmoney.co.uk.

Secret Number 7: “Investing is simple: Control the things you can control”

After examining the forces which conspire against individual investors, showing you that you cannot beat the markets in the longer term, and showing you that when it comes to investment excitement should be sought elsewhere, it is a relief to know that investment is as simple process.

Focus on what you can control without being distracted by what you cannot. Apply three fundamental drivers without emotion and investment success if firmly in your favour.

•    Risk – the amount of risk it is appropriate for you to take with your investments and how you manage that risk.
•    Structure – how you efficiently construct and manage your investment portfolio.
•    Costs and charges – minimising tax leakage along the way.

Risk and reward are related but we never know how they will play out in the short term. In the long term, however, we have a lot of evidence of how the various asset classes behave. Over time you will achieve a higher return for taking sensible extra risk with your investments. Your job is to work out what return you will need to achieve your goals and the appropriate asset allocation so that you do not take more risk than you can comfortably live with. Understanding the different types of risk will ensure that your experience is not a roller coaster ride, or, even worse, a smooth ride and then a collapse into the abyss. Managed properly through re-balancing, risk should be treated as an ally in achieving your investment goals. Only by accepting an appropriate level of risk will you be able to achieve your investment goals.

Seven Steps to an intelligently structured portfolio

After you have clarified your goals, what you want to do and achieve, and your financial plan has been laid out; after you have considered your capacity for risk; then is the time to put together and intelligently constructed portfolio of investments to help you achieve the short, medium, and long terms goals that will give you the fulfilling life that you deserve.

1.    Asset allocation will determine most of the variability in your investments. Equities and bonds is all that you need to consider and the split between the two will depend on your risk capacity.

2.    Equity allocation – equities have proved over long periods of time that they provide the highest returns compared to other asset classes. However this return has come at the price of periods of underperformance demonstrating the relation of risk and reward. Within the equity class the allocation between growth and value stocks and between large and small companies also determines your return. For example shares of value smaller companies provide a higher than average return than growth large companies. In summary value beats growth and small beats large.

3.    Diversification: The old adage of ‘don’t put all your eggs in one basket’ was never more true: spread your investments globally across a number of different types of markets and you will fare a lot better than by betting on just one market.

4.    Buy and Hold: Trying to time the market (picking the best time to buy and sell) is potentially a recipe for disaster. It may sound boring but buy-and-hold is the best approach: stick with a strategy appropriate to your goals, risk tolerance, requirements for income, and age. Avoid the temptation to change for the sake of change – if your strategy is correct from the start stay with it.

          a.    Buy funds of equities and not equities directly. Your portfolio will be more diversified and less risky as a result. You will also save money because you will incur less cost if you buy low cost smart index funds instead of direct equities.
          b.    If you enjoy picking stocks and the high risk attached then do so but recognise that it is more speculative and enjoy it for what it is.

5.    Appoint low-cost, passive fund managers: Use passive funds. Avoid chasing ‘hot tips’ and ensure that costs are minimised.

6.    Use smart index funds (better than pure index funds): Passive, low-fee, low-activity investment is likely to produce better returns in the medium and long term. However blindly following an index is not an intelligent approach. For example the FTSE 100 index follows a 13 weeks cycle where stocks on the edge are slavishly bought and sold which contradicts the rest of our advice (buy and hold, reduce costs, etc.)

         a.    Intelligent and patient smart indexing involves: deciding on an asset class; not slavishly following an index; giving some leeway so that if a small company grows and becomes a medium company time is taken in selling; stay scientifically detached and remain indifferent to stock selection; own and trade assets intelligently – disciplined but flexible, rigorous not regimented; smart not stupid.
          b.    Use advanced passive funds – while pure index funds will still generally beat retail active funds the best of breed solution is smart indexing

7.    Rebalancing: A structured portfolio maintenance program ensure that you maintain the original risk parameters that you want. It ensures that you sell high and buy low.

8.    Costs Matter: Once you give up the effort involved in speculation, the success of long-term investing is largely a case of ensuring that you get the highest return available from the underlying assets held in your portfolio. To ensure that you keep more of your return, keep costs to a minimum, and control leakage from fees and taxation.

       a.    In 2007 Christopher Trauslen on Morningstar’s website wrote: “The issue should concern fund investors and their advisers – trading costs can often be so large as to swamp other more visible fees. Like all charges, they subtract directly from a fund’s performance. Thus, if a fund’s TER [Total Expense Ratio] is 1.70% and its trading costs are 1.70% per annum, your manager will have to outperform his benchmark by 3.4 percentage points per annum just to match the index – tall order even for a very good manager. In light of their importance, it seems rather shocking that the industry, or at least the FSA, isn’t doing more to require funds to disclose trading costs in a meaningful manner to fund investors.”
       b.    Further comment from Morningstar’s Russel Kinnel observed: “In every single time period and data point tested low-cost funds beat high-cost funds … Investors should make expense rations a primary test in fund selection. They are still the most dependable predictor of performance.”

9.    Do not forget the tax implications:  Your investments should be arranged in a tax efficient manner to reduce your costs but the tax advantage should not be the reason for investing. If you put tax as the reason for investment you could be taking a very specific and often highly concentrated risk which may be very inappropriate for your life and investment goals. You may end up with an investment that does not fit your investment plan, is not tax efficient, does not fit your asset allocation, and may be expensive.

         a.    When the tax advantage wags the dog investors often end up with a portfolio of small company investments (VCTs, EISs, BPR portfolios and so on) mixed in with some structural products designed to magically turn income into capital. The costs of running such a portfolio will be extremely high and worst of all the investments ‘do not fit’. The government offers tax reliefs on such investments not because they are generous but because usually it means that the investment has an inherent downside that means that most investors would not purchase it.
        b.    While these vehicles may be used from time to time let the financial plan be the guide and driver rather than the tax situation.

10.    Conclusion:

       a.    Control the things you can control and ignore the things that you cannot
       b.    Control your emotions and biases, control the amount of risk that you take, the way you structure the building blocks of your portfolio, control the costs, the fee structure and the taxes. What you cannot control is what happens in the market – no one can. It is best not to try.
       c.    Forego the excitement of ‘making a killing’ and enjoy the experience of not falling into the abyss.
       d.    Time enables you to get the best from your investment so buy, hold, and avoid the costs of trading.
       e.    When your portfolio has been set up correctly sit back and wait for it deliver their long-term investment return. The only attention required is disciplined rebalancing.

There ends the 7 secrets of money. For those of you who have followed the last 7 months I hope that you have enjoyed and learned a lot. Over the coming months there may be some further comments and I may return to some real life examples. If you have any questions I would love to hear from you.

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