Are we finally getting back to normal? It’s great to see people out and about again as the country eases itself out of lockdown. And for all of those retail businesses that were forced to close their doors, the early signs are good with the example of footfall on Grafton Street back to approx. 90% of the pre-pandemic levels.Continue Reading –
Ethical investing refers to the practice of using one’s ethical principles as the primary filter for the selection of investment assets. Today it is seen as one element of the broader investing approach of Socially Responsible Investing (SRI). With the increased attention given to climate change, achieving a just society and the desire for good health, particularly in the current Covid era, there has been a surge in interest in SRI. Investors want to understand the impact of their money, and they want it to enhance the world we live in as opposed to simply achieving monetary growth at any cost.Continue Reading –
We carry out a lot of research throughout the year, whether it’s attending conferences and seminars, meeting investment managers and product providers and also carrying out desk-based research. Inevitably from time to time, our reading pile gets a little higher! However this is now a great time of year to make real inroads into that reading.
When scanning through some recent research, we reviewed again two particular articles that we’ve shared with you previously. Both of them are worthy of further comment and while the overall topic of each of them is different, they both in fact finish with similar conclusions.
The first piece that we wish to discuss is from Dalbar, who are a world renowned and independent expert for evaluating, auditing. and rating business practices, customer performance, product quality and service. The research that caught our eye from them is, “U.S. Investors Lost Twice As Much As The S&P 500 In 2018”.
The second piece is a superb infographic called “The Anatomy of a Market Correction” from Visual Capitalist.
So what have we learned?
First of all, the basic tenet of the Dalbar study is that investor behaviour has the single biggest negative impact on investment returns over time. Investors who continue to dabble with their funds usually end up seriously undermining the performance of them. This happens largely as a result of bad timing in entering and exiting markets. The last paragraph says it all, “year after year, the firm has found that investors are often their own worst enemy, failing to exercise the necessary discipline to capture the benefits markets can provide over longer time horizons, while succumbing to short-term strategies such as market timing or performance chasing as they did in 2018”. We see it time and time again – trying to time markets is simply folly.
The market correction research has a different focus. It examines the regular ups and downs of markets, with market corrections typically happening about once per year, with the impact of them felt on average for over 70 days. What happens then? Worried investors believe a full bull market (greater than 20% decline) is on the way and exit the market. But only 14% of corrections between 1980 – 2018 resulted in a full bear market, the rest were just blips on the radar. So investor behaviour gets in the way again…
The final section of the infographic is very interesting, comparing 3 investors, one who times the market perfectly, another who doesn’t try and time the market and a third who times it wrong each time. It’s not surprising that the third investor significantly lags behind the others in terms of returns. However what is surprising is the very small gap between an investor with perfect timing and one who doesn’t try and time it at all. It shows very little reward for market timing, which we’ve also seen is extremely difficult to get right!
So what have we learned overall? We take four lessons away from these pieces of research,
- Timing markets is folly and is not significantly rewarded even when you get it right
- Taking a long-term approach and relying on the efficiency of markets is usually the best strategy
- The key is to understand your goals and build your strategy around them, get your asset allocation right and then let markets get to work
- Accept there will be bear markets along the way
Follow these thoughts and you’re more than likely improving your prospects of investment success.
Well there is no exhaustive list for this one – there really are so many potential factors that can influence your investment returns. When you ask a professional investor, they will often jump to factors such as the economy, sentiment and interest rates. All very relevant factors.
Some factors of course have bigger impacts than others. So, we’re going to set out below the factors that we see as potentially having the biggest impacts, focusing on the factors that you have some control over – either yourself or more likely with some assistance from us.
This is not an exhaustive list and these factors are not necessarily in order, however we’ll start with the factor that (maybe surprisingly to you) tends to have the biggest impact on investor returns.
Are you surprised by this one? This factor definitely has the single biggest impact on investment performance. How many investors around the world panicked at the end of last year after the S&P 500 index fell 14% in the last quarter of 2018, and moved their portfolios to “safer ground”? Thousands if not millions of investors did – and they all then missed the 11% bounce in the first 2 months of 2019.
We see this all the time… fear in falling markets and people selling as assets get cheaper, and greed in rising markets with investors then piling in and buying expensive assets. The key is to have a clear investment strategy… and to then stick to it.
Time impacts investments in a number of ways. First of all, the earlier you can start investing allows the magic of compounding of investment returns to get to work. The longer you then invest allows this compounding to really deliver over time. This is one of the big reasons why we encourage people to take a medium to long timeframe with their investments. Also markets can be quite volatile over short periods of time, so investments held for longer periods tend to exhibit lower volatility than those held for shorter periods – another advantage of longer term investing.
Finally you will often hear us say that trying to guess the best time to either enter or exit markets is folly – none of us have a crystal ball. The key is to have a structured plan for your investments, and to then stick to the plan.
The choices that are made between different asset classes can have a significant impact on your investment – whether you are invested in equities, property, bonds or cash etc. or how much you should have in each of these asset classes. After all, the greatest stock selector in the world will have little impact on your investment returns if only 10% of your money is in equities… Asset allocation is an important driver of investment returns, and is a factor that we spend a lot of time considering when building investment portfolios.
“Star” fund managers get a lot of media attention, but their impact in reality on the returns of investors is actually relatively small. Yes they can positively impact the return on a portfolio, but this impact is quite a bit lower than most of the other factors that are mentioned. Out-performance in stock selection is also a hard one to anticipate as past performance is not a guide to future performance. Just because one investment house outperformed in recent years is not very meaningful… Understanding an investment manager’s philosophy and strategy is a far better guide than recent performance when choosing a fund manager.
Investment Costs & Tax
There are a number of factors that create a drag on investment returns that must be managed carefully. You should be satisfied that you are minimising the potential tax impact on your investments, and that any charges and expenses applied to your investment are competitive. Costs matter – you must ensure that you are receiving value for these costs. We are always happy to chat though the charges that apply to any investments, and also the different tax strategies that can potentially be deployed.
These are just some of the factors that will impact the returns on your investments, and over which you have some control. We will always look to bring your focus back to the plan – what you are trying to achieve, the investment strategy put in place to get you there and to keep you focused on that. This is the best way to grow your investments and to minimise any negative impacts.
With markets having powered ahead in recent years, in general people are happier talking about the performance of their investment portfolio. After all, it’s easier to talk about gains than losses! But we’ve noticed some conversations shifting towards consolidation of gains as the prospect of a turn in markets probably moves closer all the time. We’re not in the business of trying to time markets, but help investors to take a long-term perspective with their investments and to build a portfolio that matches your own attitude to risk.
But back to those conversations… We know there is a huge amount of terminology and jargon surrounding investments, so we thought we’ll help you sound like an expert the next time those conversations start up again.
Here are some terms that you might hear (or use!) and what they mean.
Active/passive investment: These are different approaches to portfolio management. Active management is where an individual manager will attempt to outperform through wise asset / stock selection. A passive investment approach is where a manager simply mirrors an index, such as a stock exchange index.
Annual dividend/yield: The dividend is the amount paid out to shareholders during a year, usually based on a share of the profits. The dividend yield is calculated by dividing the dividend amount paid on each share by the share price itself.
Asset class: This is a group of similar types of assets that make up an investment portfolio. The most common asset classes are equities (shares), bonds, property, cash and commodities.
Bear market: This usually refers to a fall of at least 20% from a market peak over a period of time.
Bonds: These are loans made by investors to companies or governments, in return for a fixed rate of interest and a return of the original capital at the maturity date of the bond.
Buyback: When a company believes its shares are under-priced and also has excess cash available, they will often look to buy back their shares and then enjoy the profits themselves when the shares rise in value. This is a way of returning value to other shareholders, as after the buyback, there are now less shares in circulation, increasing existing shareholders’ share of the business.
Correlation: The degree to which two securities tend to move in the same direction. A well-diversified portfolio will have lots of non-correlated assets.
Correction: Smaller than a bear market, this term is usually used in relation to a 10% drop in share prices.
Cyclical stock: The stock of a company whose performance rises and falls depending on the economic environment. For example, luxury car manufacturers saw big profits during the boom of the early 2000s… with much leaner times after 2008.
Defensive stock: Different to the above, defensive stocks aren’t impacted to the same extent by the economic environment as their demand doesn’t fall away. Companies that produce basic foods, energy suppliers and healthcare stocks are often considered to be defensive as there is a demand for these products in all economic conditions.
Equities: Shares, stocks – different names but the same thing. They represent a partial ownership of a business.
Economic moat: This is a relatively recent term, introduced by the investment guru Warren Buffett. He used it to describe a sustainable competitive advantage enjoyed by a company over its competitors.
Hedge: This is a strategy used to offset some of the risks in an investment. Companies use hedging to protect themselves against risks such as currency movements or possible future price rises of a key raw material.
Leverage: The use of borrowings to increase an investment impact. Great when a market rises, a disaster when a market falls. Remember property debts in Ireland in the early 2000s…
Market capitalisation: Market cap for short, this is the total value of the shares of a company. This is calculated by multiplying the number of shares outstanding by the share price.
Premium/discount: These terms are used to describe an exchange traded fund (ETF) that is trading above (premium) or below (discount) its net asset value, or bonds trading above or below their face value.
Real return: The actual return when the impact of inflation is included. An investment that grows by 3% in a period of inflation of 3% delivered no real return.
Sectors: These are used to describe different areas of an economy, such as financial services, construction, healthcare, technology and industrials. A well-diversified share portfolio will usually contain stocks from a wide range of sectors and geographical regions. The reason being to avoid having “all your eggs in one basket”.
Stock Exchange: There are locations, not always physical ones, where shares are traded.
Volatility: A measure of the degree to which a fund’s performance fluctuates. The basic rule is the higher the volatility, the greater the risk an investor is taking in search for higher returns from their investment.
Yield curve: This portrays the rate at which interest rates change when evaluating bonds with shorter maturities to those with longer maturities.
Of course this is not an exhaustive list, there certainly is no shortage of investment terminology. But we hope that these often used and sometimes misunderstood terms will help you shine in those investment conversations!
When we’re designing an investment portfolio for our clients, we take into account quite a number of considerations. We start by understanding your investment goals and time horizons, and then we build a full understanding of your liquidity requirements, any asset class preferences that you might have and also the returns that you expect.
This final element brings the whole area of risk into the discussion – what your appetite is for risk and also your capacity to withstand any shocks within your portfolio. We look to build a portfolio for you that, in an overall sense, reflects this appetite and capacity for risk. We want you to achieve your investment objectives, while at the same time ensuring you can get a good night’s sleep and not lie awake worrying about your investments.
We’re asked a lot about risk in an overall sense and also more specifically about the different types of risk and how they might impact your portfolio. So we thought it would be useful to set out some of the main risks that can have an impact on an investment portfolio.
However we want to start with a note of caution. This is not an exhaustive list; it is simply a list of the main risks. Please note that the magnitude and impact of risks change all of the time too, as investment conditions change. Of course we’re always happy to answer any specific questions that you have in relation to any of these risks.
This is certainly one of the most recognised risks. When there is a major economic shift, this can have quite a significant impact on investment portfolios. The last time we saw one of these was in 2008 / 2009 when the near-collapse of the banking industry plunged the world into recession, having a significant impact on investment portfolios around the world.
These are politically led events that happen across the world that create risks, which don’t always play out as expected. For example when President Trump was elected, many commentators thought that this would herald a swift decline in investment portfolios. However the opposite turned out to be the case – the S&P 500 index is up 21% since he was elected! But on the other hand, what impact would an escalation of the situation in North Korea have?
This is where individual shares can be dragged down as a result of a significant market downturn in their sector, as opposed to issues that may be affecting the individual company itself. Probably better known as collateral damage!
This risk is impacted by changes within a single country or region. The value of a currency will be impacted by economic events that are specific to that country (along with other factors). So while the investment performance of (let’s say) British stocks that you hold may perform in line with expectations, the value of Sterling will have an impact on your investment too, either increasing or reducing the value when transferring the money back into Euros.
Interest Rate Risks
We’ve all become very accustomed to an extremely low interest rate environment. However nothing lasts forever, and we are seeing signs around the world of interest rates beginning to increase, albeit quite slowly. These will impact different asset classes. For example, as interest rates rise, the yield on existing bonds falls, as investors will get a higher return from new bonds issued. Fixed interest (bond) fund managers in particular watch interest rates like a hawk! In the same vein, inflation has an impact on some bonds (where a fixed rate of interest is paid), so inflation risk is another that is carefully monitored by fixed interest fund managers in particular.
Bonds are effectively loans made by investors to issuers (governments or companies usually) in return for a coupon each year and repayment of the loan (investment) at the end of the term. There is always a risk, sometimes very small and at other times bigger that the issuer will default on the repayment of the loan. Higher risk issuers have to pay a higher coupon (rate of return) to attract money to make this risk attractive to an investor.
As stated earlier, this is not an exhaustive list of risks! We all face risks every day in relation to every aspect of our lives, managing investments is no different. However the critical lesson is to be clear about your appetite and capacity for risk, and to ensure that your portfolio reflects this. Then you can leave the fund management experts to worry about all of these individual risks, as they seek to achieve the returns you expect in order to meet your investment goals and objectives.
Lots of factors are currently creating a great deal of uncertainty for investors; Britain breaking up with Europe, President Trump settling into the White House (and everything that promises!) and continuing low growth across Europe. Then when you consider interest rates at rock bottom, uncertainty caused by global terror and other such negative factors, the picture is quite daunting for investors today.
So what do you do?
Well the answer is probably, not very much! Let us explain…
Stick to the plan
First and foremost, remember your investment objectives, and crucially your investment timeframes. In most cases, these are medium to long-term – at least they should be if you are invested in any sort of risky assets. These time frames are critical to your investment success. The markets regularly experience short-term volatility, but to try and time this volatility usually turns out to be folly. Research tells us time and time again that staying invested is the key to long-term success. Investors who look to sell out at the top and buy at the bottom usually miss both points, and often by very wide margins.
Volatility is not the enemy
Volatility is simply a feature of investment markets which go through periods of both calm and volatility, sometimes in line with the market cycle, at other times reacting to once-off events. Times of volatility have historically proven to be bad times to make significant investment decisions, as strategies tend to be coloured by short-term factors. Don’t let your emotions cloud your decision-making.
A far more robust approach to investing is to stick to the asset allocation approach that was used in constructing your portfolio, as this is more likely to deliver long-term success. There are endless examples of investors chasing that one sure bet – technology companies in the late 1990’s, bank stocks in Ireland and foreign property investments in the 2000’s. And we all know where these ended up. A key principle of successful investing is to stay diversified across asset classes, geographical regions and sectors. This will protect you against unforeseen calamitous events in a single area.
Don’t stop believing (or saving)
When short-term volatility happens, some investors are slow to commit more money to their investment strategies. This is effectively trying to time the market. It’s important that you keep the faith! Keep investing, although talk to us about the best way to do this. It may make sense for you to employ a strategy such as “euro cost averaging”. This is where you invest a fixed amount at regular intervals. This ensures that if markets are moving around, you are buying in to the market at various price points, thus ensuring you’re not exposed to the risk of investing and be exposed to an immediate fluctuation.
Look backward as well as forwards
While of course we are always at pains to point out that past performance is not a guide to future performance, at the same time it’s sometimes worth looking back and seeing where you came from. This hopefully will give you confidence in the future! Look at an investment that you’ve had for a long time – this could be an old pension fund, a children’s education fund or even your family home. Or for example, just look at stock market returns over any 10year+ time frame. With very few exceptions, the results are extremely heartening. This will give you a sense of how time is your friend and will bolster your confidence to stick with a consistent investment approach throughout good and bad times.
Often it simply makes sense to sit down with an expert who will look dispassionately at your situation and reassure you, or guide you towards a change. We would be delighted to help you.
Important: Past performance is not a guide to future performance
Image courtesy of Michael Vadon
We understand that building an investment portfolio that meets your specific needs is no easy task. There are a few fundamental principles that we consider when advising you in this regard.
First of all, the aim in building a portfolio is not about “picking winners”, as this is a sure-fire recipe for disaster! Instead a portfolio needs to be constructed with an asset allocation that fully reflects your appetite for risk. This is why we spend time at the outset clearly establishing your own appetite for risk and then help you to build your portfolio from there.
Secondly we are firm believers in the importance of diversification in a portfolio, the concept of not having all of your eggs in one basket. The merits and de-merits of all asset classes need to be considered when building the portfolio. This brings us to the subject of deposits and their place in a portfolio today.
Deposit accounts have their (limited) place
There’s no doubt that deposits always merit some consideration when building a portfolio. They used to be considered risk free, however this notion was tested somewhat during the financial crisis as some banks teetered on the brink! However they are generally recognised as a very low risk investment vehicle, which is attractive to some investors. They also are extremely liquid. You can walk into a bank, and if your money is in a demand account you can withdraw it all on the spot. Deposits also make a lot of sense if your investment horizon is very short.
Never forget about diversification
However there are also issues with deposits that cannot be ignored. Some savers simply put all of their money in the bank and leave it there. This may be a mistake for a number of reasons. First of all, this approach may not suit your appetite for risk and it completely undermines the merits of diversification. Depending on your investment timeframe and risk appetite, you may be better served by also considering other asset classes in order to achieve your investment objectives. Yes, there is very often merit in having some of your money on deposit, however it often makes more sense when your money is split between deposits and other asset classes.
Timing markets is folly
Of course some people like to keep their money on deposit while they wait for the markets to fall, with a view to jumping in when investment assets are cheaper. From our experience this is folly, as trying to time the markets is not much different to trying to pick winners. Typically when investors try to time markets, they miss the peaks (to sell out of markets) and the troughs (to buy into markets) to the detriment of their investment portfolio. And they end up constantly questioning themselves, “Is now the time to buy / sell”? Statistics have shown time and time again that successful investors stay invested through good times and bad. They make sure that their portfolio reflects their risk appetite and as a result, they can live with the swings and roundabouts of the markets as they take a longer-term view of their investments.
Coming back to the title of this article, seasoned investors recognise that market volatility is simply a feature of investment markets. They learn to accept it, once they have a risk-based portfolio in place that reflects their own appetite for risk. If deposits have a place in that risk-based portfolio, then they should be included. Removing volatility altogether is not the answer.
Negative interest rates?
And then of course, you just can’t ignore the really poor interest rates that are being offered on deposits. We’ve recently seen one of Ireland’s main banks starting to charge corporate customers for the pleasure of holding their money, rather than paying interest! And while this trend hasn’t carried through to consumer deposits as yet, already a number of the banks are paying 0% or very close to it to consumers on demand deposit accounts, meaning your hard earned savings are simply treading water. And then to cap it all off, DIRT (deposit interest retention tax) has been increasing over recent years and now stands at 41%. It’s hard to win with deposits!
In summary, deposits always warrant consideration and often make sense as part of an overall investment portfolio. However tying all of your money up in deposit accounts may not be the wisest strategy.
Investing today can be a bit of a minefield. You could end up paralysed by fear, worrying about the possible impact of the likes of Brexit, market fluctuations, elections here and abroad and terrorism threats! However as your financial adviser, we remain focused on your long-term investment and pension objectives, and always do our best to keep you on track to achieve them.
Of course we remain vigilant about all of these potentially damaging events, but all of the time we stick to some important principles that have stood the test of time for investors for many years now.
Learn the Market Cycle
The investment market usually (but not always) follows a typical cycle as shown below. While you obviously cannot rely on all of the different factors coming together as illustrated, this is a useful picture to bear in mind.
There are always anomalies, such as the unprecedented low interest rates that we’ve seen in the last few years, but remaining aware of the market cycle can help you to avoid letting greed or excessive caution cloud your judgement.
Diversification is key
There is always the temptation for investors to follow the latest and supposedly greatest hyped-up investment. This might be investing only in property (remember what happened in Ireland 10 years ago…) or indeed acting on a great share “tip” that you got. Putting all of your money into one area is an extremely risky strategy; if it goes wrong, you could lose the lot.
Always spread your risk and build your wealth through funds or pools of assets. This diversification will give you some protection against one of the companies you’re invested in, or even one of the asset classes going south.
Volatility is okay!
When people get fixated on short-term changes in their investment and pension assets, volatility can cause a lot of concern. The focus turns to those short-term dips in returns and investors get anxious.
However volatility is simply a feature of long-term investing. Markets will go up and down, the critical tactic is to stay invested and not react to short-term factors.
Trying to time markets is folly…time and again it has been proven that you are better off riding out the peaks and troughs, rather than trying to call them yourself. However if you really struggle with the volatility of your portfolio, it’s possible that you don’t have the right risk-adjusted portfolio for you in place. Give us a shout, as we’ll help you to identify your appetite for risk and will design a portfolio that will allow you to sleep at night!
Know the magic of compound interest
Compound interest has a huge impact on investment and pension portfolios. For this reason, it is really important to start investing early, and to keep investing. The more time each tranche of your investment has to grow allows the magic of compound interest to really deliver!
To help see the effect of compound interest, it’s worth remembering the ” Rule of 72″. This is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself. For example, the rule of 72 states that €100 invested at a 10%p.a. return would take 7.2 years ((72/10) = 7.2) to turn into €200.
Knowing this rule will help manage your expectations in relation to the performance of your portfolio or will help you identify the return needed to double your money in a specific timeframe.
Time and compound interest are great friends of investors!
Cash costs you money
Cash in the bank today is simply a missed opportunity. Yes it is a safe haven and staying true to the diversified portfolio principle, it makes sense to have an allocation of your portfolio in cash. But many investors today have too much of their money sitting in the bank, being eroded by inflation and very low interest rates.
You have long-term financial goals and probably need a level of investment growth to achieve them. Leaving your money sitting in cash is likely to undermine your chances of achieving your goals.
At the end of the day, investing is not always straightforward. Your emotions, doubts and behaviours can get in the way and undermine your likelihood of success. But that’s where we come in. As your independent financial adviser, we can be completely objective and can help you plot your course to help you ultimately achieve your investment goals. These are a few tips to help you along the way – we of course would be delighted to discuss any of these or indeed any aspect in relation to your investments.
Warning: If you invest in these funds you may lose some or all of the money you invest.
|Warning: The value of your investment may go down as well as up.|