The Art and Science of Investing
As I write this article the world’s stock markets are experiencing significant volatility. Markets fell by as much as nearly 5% in one day, but recovering the next. Television and newspapers (we are told that good news doesn’t sell) are full of doom and gloom, reporting a global “sell-off” of shares. Sadly, evidence tells us that many ordinary investors also panic during such periods, invariably damaging their wealth. Our message comes from Dad’s Army; after all, it was Corporal Jones who said “don’t panic, Captain Mainwaring”.
We believe that there are seven key components of a lifelong investment strategy – the Art and Science of Investing, as we call it at FFP. Over the coming months we will endeavour to explain these components.
It is widely accepted that strategic asset allocation – i.e. the setting of long-term allocations between equities, bonds, cash and other asset classes, and the subsequent adherence to these weightings – is the most important driver of long-term performance and volatility. Risk and return are related; they have to be as no one in their right mind would take extra risk if there was not at least a prospect of it being rewarded. Buying shares, being a part owner in a company, is considered riskier than buying bonds, lending to (safe) governments. While the return from shares, in the long run, is likely to be greater than the return from bonds blending both asset classes can often increase returns as well as reducing risk.
In order to set the right asset allocation, discussion is needed regarding future goals, the investment time horizon, risk tolerance, contribution and spending levels to name but a few. Many people understand their risk tolerance (how much risk they are comfortable with) but very few understand how much risk is required to meet their goals. After all, if you’re likely to have enough why take unnecessary risk?
Most investors do not know their asset allocation. In the main, they have portfolios based on “fund collecting” rather than being rational choices based on their own personal circumstances. The Financial Services industry is marketing led; “flavours of the month” sell much better than a sound intellectual framework for investing based on the enduring benefits of asset allocation, diversification and discipline. A simple well thought out portfolio is likely to deliver performance at least on a par with many highly sophisticated and complex portfolios, at lower risk.