Now that we have a good understanding of our global asset base; any tax implications to be aware of and how to effectively structure accounts, we can move on to looking at our approach to investing.
In this month’s edition of the roadmap, we focus on building a coherent investment strategy.
Building Blocks
Risk
The first step is to determine your risk profile, identifying how much risk you are willing and able to take. Those with a higher risk profile have the ability to make markedly higher returns but at the prospect of larger losses. Also known as a risk versus reward scale.
Understanding your global asset base; financial knowledge/experience and objectives all play an important role in creating a risk profile.
It is also fundamental that a time horizon for when the capital invested/income may be required is established as this will determine your capacity to take risk.
This risk profile will then help shape an investment portfolio and the subsequent asset classes within it.
Currency Requirements
Investing in a multi-currency investment strategy allows you to invest in a larger universe of assets and opportunities and allows you to diversify risk. However, should the rate move against your preferred currency (the currency you live on), this can negatively impact your return and therefore needs to be considered in any investment strategy. This becomes more important as you start requiring capital/income from the portfolio.
Liquidity
Certain financial products and instruments require you to lock funds in for a certain amount of time, which means you are unable to withdraw your money (either at all or with a penalty). Investments can also be illiquid in nature (such as real estate), which means that you are unable to take your capital out or re-organise to another asset class should market conditions suggest it is wise to do so. Keeping a larger proportion of funds in liquid holdings gives you more flexibility to make changes.
Environmental, Social and Governance (ESG)
ESG considerations are becoming material enough to affect investment decisions. There isn’t a one-size fits all approach as any considerations within a portfolio are subjective to the investor. Important note: it is more difficult to filter the types of asset you purchase within third-party funds and any ESG restrictions will reduce the universe of available assets.
Asset Allocation
Once you have the building blocks and understand your restrictions (also known as a risk mandate), it is time to populate your portfolio based on the different asset classes (such as cash, commodities, stocks and bonds), so that you have a diversified pot, designed to be more resilient in different macroeconomic environments.
The asset classes will be allocated dependent on how much risk they add to the portfolio to ensure it is in line with your risk mandate and expectations for markets.
Allocations to different asset classes will change over the course of an economic cycle to suit market conditions. It is therefore important to understand the role of each holding within your portfolio, not be overly concentrated in any one position and have assets that are uncorrelated (move in different ways) to provide compounding growth over the long-term.
Tax
Different asset classes will incur various types of tax, dependent on where the asset is based and what type of return they generate (e.g., capital gain/interest/dividend). To compound growth, it makes sense to allocate the higher tax generating assets in the more tax effective wrappers i.e., retirement accounts.
Timing
“It’s not about timing the market, but about time in the market,” trying to pick the right time to invest is almost impossible, it is much more important to stay in the market for the long-term within a diversified pot.
Ongoing Management
The ongoing review and structuring of your portfolio is imperative to meeting your goals as life changes. This, along with tax legislation and shifting markets means it is a large topic which we will discuss in part 4b of our roadmap series.
