Layers of Investing - Where to begin
Layers of Investing – where to begin
The range of options available to investors can often be overwhelming. Where do you even begin? To answer this question it can be useful to break your investment decisions into three simplified layers:
1. The ‘why layer’ tries to establish exactly what your investment objectives are. It attempts to answer the question as to why is it that you want to invest.
2. The ‘when layer’ tries to match your investment objective with an appropriate investment time horizon of the solution considered.
3. The ‘where layer’ tries to tie together your investment objective, appropriate time horizon and investment geography. Within each layer come other considerations, so let’s go through each one in more detail.
The Why Layer
The why layer is a good starting block on which to base your investment decision as it lays the foundation for asset classes that might be appropriate for you, given your objectives. Your ‘why’ might be that you would like to put down a deposit on a house in 12 months’ time. In that case an investment that could be characterised as short-term might be appropriate. Alternatively, your ‘why’ might be that you would like to start planning for your retirement right from your very first paycheck (good for you). In this case an investment characterised as longterm might make more sense. Either way, you have now established a ‘why’ and can move on to the ‘when’.
The When Layer
Now let us consider your investment time horizon and your volatility risk profile. A volatility risk profile refers to up and down movements on your investments and how willing you are to absorb these movements, whereas your time horizon refers to the projected length of time over which an investment is made or held before it is liquidated. This might sound a bit technical but the concept is actually very simple.
Going back to our previous examples: You need a certain amount to put down a deposit on a house in 12 months’ time. Let’s work with a future value of N$100,000. Thus your investment objective is N$100,000, your time horizon is 12 months and your volatility risk profile would most likely be very low. A low volatility profile means that you are not willing to see large fluctuations in the value of your investment and would prefer a steady rate with a steady return that will result in the amount of N$100,000 with a high level of predictability. For instance, if you worked on a money market rate of 7.5% on an annualised basis (compounding monthly) you could calculate what you would need to put away per month to reach your future value of N$100,000. In this instance you would need to put away ~N$8,050 per month for 12 months to reach your objective.
...when you finally need the funds as per the original objective, you don’t want to be in a situation where timing in the markets worked against you...
As another example let us consider a 30-year-old who is saving for her/his retirement. Now the time horizon is 40 years (if this particular investor plans to retire at age 70). Suddenly volatility is not such a big risk as the up and down movements over a 40 year period becomes less about what happens in the short to medium term and more about the overall return during the entire effective period of the investment. Now a portfolio with a higher weighting in stocks might become more appealing. When compared to cash type investments, a stock portfolio, by nature, is very volatile over the short to medium term, but over longer periods the likelihood of a well-diversified stock portfolio outperforming its more conservative peers tends to increase. A typical stock portfolio needs at least seven years to absorb the effect of volatility.
In summary, when you finally need the funds as per the original objective, you don’t want to be in a situation where timing in the markets worked against you and resulted in a partial loss short of your objective.
The Where Layer
Once you have established the appropriate investment vehicle according to your time horizon and volatility profile, you may want to consider diversifying your portfolio among different geographies and different asset classes. Investing in a well-diversified portfolio that caters for your short-term objectives (saving for a house) and your long-term objectives (saving for retirement) with an appropriate mix of local and offshore investments, could very much result in the all-weather portfolio that you desire.
With the right planning you can achieve your investment objectives without feeling overwhelmed by choice. There are many other factors to consider, of course, such as liquidity constraints, tax constraints or even personal preferences regarding certain investments that you would like to avoid. The point is that when deciding on ‘where to begin’, one should consider taking a holistic view that is unique only to you, as your ‘why, when and where’ could be very different to that of your friends.
William Ross Rudd is the Wealth and Portfolio Manager at IJG, an established Namibian financial services market leader. IJG believes in tailoring their services to a client’s personal and business needs. For more information, visit www.ijg.net.
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