Creating an investment portfolio whether for retirement, education costs or just simply to set some money aside for the future can sometimes appear quite daunting. I believe this can be due to the number of products available with complicated sounding names such as ETFs, OEICs, Unit Trusts, Structured Products, etc together with the jargon associated with the financial services industry.
One of my favourite sayings is that “the confused mind says no”. Because of this I try to simplify what can sometimes be complex issues.
To give an example:
It is generally accepted that the asset allocation of a portfolio is the dominant factor affecting the variance of the long term returns. What does this actually mean?
To explain:
Portfolios are generally constructed of growth assets, let’s call these whiskey and defensive assets, let’s call these water.
The blend between the whiskey and water elements is the asset allocation and deciding on this blend is very important.
I believe most investors would ideally like the highest return from their portfolio and this would be a 100% whiskey portfolio. As risk and return are related, this portfolio would likely have the highest volatility. This means that the value of portfolio could vary up and down over time to a large extent.
These extremes in portfolio values may be too much for the investor, they may panic and sell thus crystallising any losses. It is highly probable in this scenario that the investor may not have achieved any better return than leaving the money in the bank yet had a negative emotional journey.
To combat this, the portfolio can be diluted with water assets, this reduces the volatility and also the expected return, hopefully to within acceptable levels (accepting that we don’t know the future). It is a trade off.
To arrive at a whiskey/water blend it is important to consider your attitude to risk, your need for risk (based on your financial plan) and your capacity for loss. Combining these factors enables the right blend to be ascertained as some people drink neat whiskey, others are teetotal with everyone else somewhere in the middle.
My personal experience is that by using analogies like this, the investment process is simplified and understood thus greatly increasing the chances of someone sticking with their plan and therefore achieving their goals.
Warm Regards
Neil
This article should not be considered investment advice or an offer of any product for sale, it contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular, strategy or investment product. Information contained has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not an indicator of future results.
