What To Invest In?

In previous blog posts we outlined our Investment Principles (https://money-mentor.ie/blog/investment-principles) and How To Invest (https://money-mentor.ie/blog/how-to-invest). Building on the back of these posts we now turn our attention to What To Invest In.

How we build our portfolio will be determined by our investment goal, savings rate, time horizon and required rate of return. Those looking to build wealth with a long-time horizon (30-60 years) will be seeking to maximize return during the accumulation stage. The accumulation or saving stage is from birth to financial independence.

Those who are already wealthy with a shorter time horizon (10-30 years) are more likely to want to preserve the wealth already created while balancing the need to maintain the purchasing power of their money into the future. When we have something to lose, we prefer to avoid loss. It is only natural to want to minimize the potential for significant loss when relying on an investment for income. The decumulation or spending stage is from financial independence to when we pass away. We will need to achieve a minimum investment return beyond inflation, charges, and tax (if applicable). Before diving into what to invest in, I want to reiterate some investing fundamentals:

Inflation

The real risk to our wealth building efforts is inflation. The gradual erosion in the value of our money is the primary reason to invest. The inflation table below details how many years it would take inflation to halve the value of our money if the average inflation rate was:

The past decade of inflation has been unusually low, historically speaking. Inflation was in the late teens and early twenties during the late 1970’s and early 1980’s in Ireland. A basket of goods and services that cost €100 in December 1930, now costs €5,938 in July 2021. This ninety year plus period is a lifetime of inflation.

Investment Market History

There have been decades where returns from public businesses have failed to perform. From 1900 to 1920 performance started and finished largely unchanged. The 1920’s saw a boom often referred to as the roaring 20’s which ended with the Great Depression in 1929. The 1930’s was spent recovering from the Great Depression. The 1940’s and 50’s experienced another boom. The 1960’s and 70’s saw the market plateauing. The 1980’s and 90’s we see a surge in performance that ends with the Dot Com bubble in 2000. The 2000’s are referred to as the lost decade as it begins with the Dot Com bubble bursting and ends with the Great Financial Crisis. From 2010 to 2020 businesses recover and go on to reach new all-time highs with a temporary short sharp decline in 2020 as the Covid-19 pandemic gripped the world. 

The JP Morgan Guide To The Markets is a great historical resource for those with some preexisting investment knowledge: https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/

Loss Ladder

The first rule of investing is to avoid permanent loss. The second rule of investing is to not forget the first rule. Permanent investment loss is one from which we can’t recover. A permanent loss is achieved when an investment goes to zero or we panic and sell during a temporary market decline. Risk of permanent loss is high when gambling, middle of the road when speculating and low when investing is done right, so long as the investor behaves in accordance with their financial plan. The investment loss ladder is outlined below:

The Nasdaq Index which is an exchange heavily weighted towards information technology companies declined by nearly 80% during the dot com bubble crash of the late 1990’s and early 2000’s. Being heavily concentrated in one sector can leave an investor exposed to significant investment loss and a mountain to climb to get back to where they started.

Diversification

Diversification can be a topic of heated debate between the active and passive community when discussing investment strategy. For those that really know what they are doing (and there are very few 10%-20%), concentration is preferred over diversification. Diversification is seen to dilute the ability to outperform and beat the market. Those that diversify will ask, do you need to pay for and accept the added risk in the pursuit of outperformance when 80%-90% of active managers fail to beat the market long term? The SPIVA – Active V’s Passive Scorecard provides useful analysis on the percentage of active managers underperforming the S&P Index: https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2020.pdf

For those that don’t know what they are doing (most of us), diversification should be a key ingredient in our investment strategy. The simple benefits of diversification are highlighted in the sequence of returns from two different stocks below:

Investment Portfolio Construction

For the purposes of this blog, I will assume the first port of call for those building wealth and seeking financial independence is a pension given we keep more of the money we make and its tax deferred benefits. Therefore, our investing universe is limited to the following asset classes:

·         Cash/Deposits

·         Government & company debt

·         Property

·         Public businesses

·         Alternatives

If all portfolios started with 100% public businesses, we then reduce that percentage based on our:

·         Investment goal

·         Savings rate

·         Time horizon

·         Required rate of return

·         Risk tolerance

When we have defined the above criteria and blended them together in a realistic manner, we will have a clearer picture of how we will need to construct our investment portfolio.

The triple threat of real investing is that the asset class appreciates, provides an income and a rising income long term. Historically, public businesses have provided the best long term investment returns. They appreciate, provide an income in the form of a dividend and a rising dividend long term. If selecting public businesses as part of your investment portfolio there are a number of options to diversify within this asset class that can impact your risk and return:

·         Countries

·         Size

·         Industries

·         Factors

Government & Business debt appreciate, provide an income in the form of yields (interest) and a rising income long term. Debt has provided a return one or two percent above inflation over the long term. If public businesses are the whiskey, government and business debt is the water. It is an emotional asset class to dilute the ups and downs of owning public businesses. The percentage you allocate to bonds should be proportionate to the risk you are comfortable with. As previously mentioned in the investing episode of the Money Mentor podcast, Jack Boggle surmised a very general rule of thumb to keep the same percentage of debt as your age with the rest in public businesses. If selecting government and business debt as part of your investment portfolio there are a number of diversification options that can impact your risk and return:

·         Countries/Businesses

·         Duration

·         Quality

·         Inflation Protection

Once we have decided on our desired investment portfolio split, we pivot to which funds will best assist us achieving our investment goal. When selecting funds to match our desired portfolio asset allocation there should be a variety of Active & Passive fund options available. Depending on your own philosophy you can choose one or the other or a hybrid of both. Just be conscious of fund costs and the rational for paying more for one fund over another.

If it isn’t obvious already, the need for advice is instrumental in optimizing your portfolio for your desired investment goal. You can get lucky with a default option. Do you want to gamble your financial future on a one size fits all approach? There are also the DIY’ers. It’s unlikely I know how to do your job as well as you do, so I think it’s equally as unlikely you know how to do my job as well as I do. If you want to save time, money, worry and stress, seek and pay for a good financial planning mentor and adviser.

Link to Spotify podcast episode: https://open.spotify.com/episode/3ercU7Brhf4zbOSViiVzMs?si=5edea27e7cb54afd

Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s2-e10-what-to-invest-in/id1539630506?i=1000543003590

 For personal financial planning advice email team@vantagefp.ie or call (01) 539 2670.