What drives returns?
We believe that ‘asset allocation’ (the balance between different asset types held, say, stocks and shares-versus property-versus fixed income) is mainly what drives investment outcomes. Not clever stock selection, which is expensive and only has a small chance of getting you extra returns after the extra costs have been factored in.
Beating the market through stock selection is very difficult. Not impossible, but statistically improbable, even harder to do consistently, and - as a result - hard to hang a financial plan on.
You should understand that any decision to move away from an indexing approach (tracking markets at low cost), while potentially being a valid approach, adds an extra element of speculative risk and has a relatively low probability of outperformance.
The importance of reviews
Markets, and investment approaches, are not static. So, our investment approach is reviewed regularly to make sure it remains optimal for our clients. We also don’t believe clients are best served by leaving their investments to run without being reviewed. A portfolio should be adjusted over time, to ‘rebalance’ the risk and return profile and account for any changes to your circumstances and goals.
Some of our work is transactional, but the vast majority of clients have an ongoing engagement, where we revisit their plans periodically to keep everything moving in the right direction. It’s not compulsory, there are no tie ins, but we do strongly believe this is the best way to work with us.
Needs based investing
What is ‘needs based investing’ and why do we think it’s so important? The investment industry has, in the past, tended to rush towards the how before the why. Products and an approach to investment risk without properly exploring client needs.
We believe that most investors benefit from building their investment strategy around detailed, individual lifetime cashflow forecasts, which aim to identify the returns they need to generate from investments to make their plans happen, and the risk which can reasonably be taken in pursuit of those returns.
Whether they realise it or not, investors who are dependent on their capital to meet their goals are balancing two competing types of risk. On the one hand, by holding ‘real’ or ‘risk assets’ (like stocks and shares) returns will be variable, and volatile, with a risk of loss along the way. This is called ‘capital risk’ and it is the kind of risk investors tend to focus on, because the effects are felt keenly. On the other hand, ‘inflation risk’ is also a big factor for investors over the long term. This is the risk that your expenditure needs increase with inflation, but your capital doesn’t grow as quickly, reducing its spending power. These risks pull in different directions, there’s no right or wrong mix, and there’s also a human element. Some people will have a high tolerance of capital risk and it will make some people very uncomfortable. But it is true to say that most investors are, rationally, risk averse, and will favour the same return for lower risk if they can get it. The problem is that when you get sold a product, there’s a good chance you will end up something that is too risky for what you need. We often take on clients with existing portfolios which have more risk than those investors want or need.
At the other extreme, we meet people who are put off by the world of investing, for some understandable reasons, so they hold excessive cash balances, with low returns and poor inflation protection.
The challenge is to find the right balance. Without an individual financial plan, it’s very hard to decide the right level of risk and return. Our ‘needs-based’ investment approach is about aligning the risk / return trade off with your individual situation and goals. Enough risk to get the returns you need, but no extra risk for its own sake.
And if you can meet your goals without investing at all, and cash will do the job, we’ll tell you that. That’s important. If you don’t need a product we won’t try and sell you one.
Your capital is at risk. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
