2016 hasn’t been a great start for investors. Indeed the recent stockmarket volatility has been stressful for investors when they see the value of their investment continue to fall.
So the investor then has two simple choices; stay invested OR move into lower risk assets – typically cash / bonds. The difficulty with the second choice is that the investor makes the loss ‘permanent’ – i.e. they don’t benefit from any upside in the markets – as they are now invested in ‘cash’. This first approach does help to draw a line under the ‘stressful period’ – the problem is the line is a ‘straight line’ – indeed if you stay in ‘cash’ you now have a new challenge; when should I move out of ‘cash’ into higher risk assets. If you don’t move out of cash you continue to lose the purchasing power of your monies – as inflation nibbles away at it!
The first option – staying invested – takes a little more effort – you have to anticipate more potential losses (albeit they may be short term in nature) and you need to be patient – to allow the market move upwards – when the bottom has been reached.
A relatively simply (but effective approach to investing) is to split your portfolio into two sections; the first section represents ‘defensive’ or lower risk assets (cash / bonds / targeted growth funds) and the second section will include growth / risk assets (typically Equities / Commodities).
Property can fall into either category – where the fund is providing ‘gearing’ (the fund borrows to purchase property on behalf of the fund) this clearly falls into the growth / risk assets. Where the property fund invests in ‘bricks / mortar’ this might be classified as a ‘defensive asset’.
If you can ‘accommodate’ losses of circa 20% (I am not suggesting that you would settle for this at maturity) from time to time during your investment period this might suggest that you should hold no more than 50% in equities. A ‘peak to trough fall’ of 40% (this is relatively pessimistic) would result in a 20% loss on your equity holding.
The defensive assets are not ‘guaranteed’ but you might anticipate that averaged over 3 / 5 years the return on these assets might be of the order of circa 2.5% p.a. – 3% p.a. Hence if 50% of your portfolio is likely to generate 2.5% returns this would help to ‘offset’ the 20% loss on the equity holding.
Remember that to make an investment return (i.e. the value of your investment generates growth in excess of inflation) you do need to take some degree of risk – so for relatively cautious investors the availability of ‘targetted’ returns (funds which aim to generate returns of ‘cash’ + 4% p.a. / 5% p.a. over a 3 / 5 year rolling investment period) has to be welcomed. These funds DO NOT offer the investor a capital guarantee but they do help to set out a clear blueprint of the potential upside / downside of the fund.
These funds might suffer ‘downside’ losses of circa 30% of what might be expected by a pure equity fund. So if a pure equity fund was to lose 15% in a volatile market you might expect the ‘targeted return’ fund to suffer losses of up to 5% over the same period.
Remember when you have ‘determined’ the split of each of the sections it is important to be well diversified within those different sections (i.e. the defensive assets might be split between government bonds AND corporate bonds rather then invest solely in government bonds.)
There is no perfect answer to getting it right but these guidelines can act as a useful start.
If you wish to discuss this article in further detail don’t hesitate to contact me at Full Circle Financial Services in Stillorgan on 01 2530060.