In the fifth, and last, in our series of golden investment rules, we look at the importance of establishing a suitable asset allocation, and why you should maintain this over time by rebalancing your portfolio periodically.
As investment advisers, the most common question we are asked is: “Where is the best place to invest my money at the moment?” Indeed, a colleague was recently asked this by a consultant anaesthetist whilst being prepared for a minor operation! His answer, as mine always is, was: “It depends on your timescale and what you will need the money for.” Whilst this answer rarely satisfies people’s need for a quick fix, it is always the correct advice and, as with all of our investment principles, heavily backed up by academia.
Numerous academic studies have shown that the majority of your investment returns (over 90%) are dictated by simply what asset class you are invested in; so not by the manager’s skill in choosing stocks or timing the markets. This theory can be tested anecdotally by checking the top performing funds in the money section of any of the Sunday newspapers; they will almost always contain funds from the same or very similar sectors in any given week. Indeed, if you look at the performance of same sector funds from different investment houses over the longer term, the performance is usually very similar even though those very same managers will be claiming all of the credit in the good years and blaming it on the markets and external events in the bad years.
So, in reality, higher risk assets will have a higher expected return over the long-term, albeit with greater short-term volatility. You should therefore construct your portfolio in such a way that takes account of your personal circumstances; lower risk, less volatile asset classes for short-term requirements, with a mix of longer-term asset classes based on your overall risk profile, time horizons and growth needs. The golden rule is then to stick with it! Your long-term asset allocation should not be changed as a result of short term events, press speculation, or, indeed, your own predictions of the future, and should only be adjusted if your risk profile, personal circumstances or financial requirements change.
Another factor to consider is how different asset allocations will vary over time. Clearly, as different asset classes will perform differently over time, you may find that when you come to review your investments, the asset allocation has diverged from what you had agreed to (and were comfortable with at outset).
Our solution (as always, backed up by countless academic studies) would be to rebalance the portfolio to return it to your originally agreed allocation. This serves several purposes: first, it is a natural way to 'sell high and buy low'. Whilst people at first may not be comfortable with buying more of the worst performing asset classes or sectors, and selling the better performing ones, it is a more scientific way of following the old stockbrokers’ mantra of ‘buy low, sell high’. Secondly, it reduces portfolio volatility and risk, by ensuring that the higher risk assets do not form a larger part of your portfolio than you are comfortable with. Lastly, it takes all of the emotion and biases out of your investment decisions, by providing a structured framework to invest.
So, hopefully, if enough people read this, we may start to hear: “What is the most suitable asset allocation for my requirements?”, which is what people should really be asking!
This is the last in our series of golden investment rules. All of the previous articles can be accessed below:
1. Invest, don’t speculate
2. Maintain discipline
3. Control costs
4. Diversify systematically
5. Maintain asset allocation
If you have read all of the golden rules, you will now, hopefully, appreciate that there is much more to investing than just 'speculating to accumulate'. Our preferred approach is known as 'evidence-based investing' and draws on over 50 years of academic and statistical evidence and also Nobel Prize winning studies on stock market behaviour. Our recommended investment strategy can be incorporated within self invested personal pensions, ISAs, trusts and investment bonds, as well as directly-held investment portfolios. We would be happy to discuss the Moore Stephens Intelligent Investment Strategy, so please contact us if you are interested in seeing our investment presentation. This lasts about 45 minutes and will be quite an eye opener in how to best invest for the longer-term.