Balanced Investing is not a foreign topic of discussion at Fairtree Invest. There have been several articles and webinars around this topic. Why? We believe it is an important concept to grasp, with many facets to master balanced investing.
Balanced investing is all about allocating your funds across different assets, to ensure long-term growth and a nice diversity of investments that perform well at different stages of the market cycle. Some assets will perform better in market contractions/ recessions than others. Similarly, when the market is booming, other assets tend to outperform. The foundational principle here is ‘time’ and staying invested for the duration of that time. Different risk assets have a principle of time connected to them. The higher the risk, the longer one should stay invested because over time that capital growth compounds hugely. There is a very common underlying theme across balanced investing principles and that is understanding risk and managing it. However, what is investment risk?
Investment risk is a very broad term that means different things to different people. To some it is danger, others it is caution, opportunity, or excitement. Risk can be defined as the possibility of something not turning out the way you would have liked or differently from how you previously supposed. This could mean potentially losing some of your initial capital invested. However, risk can also mean greater growth potential. Your investment value can move up or down. The degree to how much it fluctuates is dependent on the amount of risk taken. Risk is determined by what asset classes we invest in. ‘Risk-return trade-off’, means the higher the investment’s level of risk, the higher the potential return. When looking at your investment options, it is important to consider how much time you have to invest, what is the reason you are investing for, your unique financial situation, and then how much risk you are willing to take on.
Risk is the thing that will tempt us to not stay invested. Risk comes in many forms, so we need to be mindful and alert on how to determine how much risk we can truly stomach. When structuring a personal investment portfolio, people usually approach it through the following two steps, often getting the order wrong.
1.First, look at what is currently performing well and allocate their money to that investment.
In essence, they are selecting their assets and asset classes first. (Equity, stock, bonds, property, etc)
2.Second, once they are already invested, they come to understand how much risk they can actually handle, through experiencing the fluctuations in the value of their portfolio.
Often, investing in this way tends to result in disinvesting too early and people end up losing money. Some investors love the adrenaline kick of investing, others may feel like it is too much of an emotional roller-coaster and that they are spending way too much time monitoring the ebbs-and-flows of the market. Investing does not have to be this way. There are much better ways to invest that will allow you to have a more confident and relaxed approach, all the while still achieving those investment goals. No one invests money intending to lose it. Risk will always be a factor when it comes to investing in the market. We should never adopt more risk than we can actually handle. Many people try to outsmart the market by moving in and out of investments. However, few try to outlast it. Patience is king when it comes to long-term strategic balanced investing. So wait.
However, how can we ensure that we wait well?
The answer, rather reorder the above two steps:
1.First, determine how much risk we can handle to stay committed to the investment strategy’s duration. Remember the investment strategy is designed for outperformance over a specific period. Stay committed.
2.Second, once we have determined our risk appetite we can invest in the correct assets and make sure that they are diversified.
There are factors other than market fluctuations that are often overlooked when it comes to figuring out our individual investment risk profile. Stomaching possible capital losses is only one part of risk. Each of us has a unique set of financial habits, needs, goals, as well as psychology and emotions toward money. As a personal investor, your success lies in understanding your own strengthens and weaknesses when it comes to finances.
Investing is personal. Simply, looking around at; what performs well currently, what are the other people doing, and what shares have other people bought, speaks nothing about our personal financial situation, our personal investment goals, and our personal response to losing money. The key to successful investing is knowing ‘you’. Applying wisdom and theory to ‘your situation’ and ‘your risk appetite’. We cannot compare ourselves to the Jones’ because, in our own capacity, we are not them. We are unique and so are our lifestyles. For example, retirees generally seek financial security, but if the retiree withdraws 10% of their capital as income each year, they are forced to take risks, otherwise, the capital will dry up and the income will not be sustainably addressed. Similarly, investors who are young and saving for retirement will be able to take a lot of risk as they have the luxury of a very long investment term.
Other factors to consider to help us determine what our risk appetite is:
Our Investment goal
Purpose is important, not only in life but the reason for investing too. What is the goal of the investment? Save toward a house, start your own business, buy a car, purchase an engagement ring, go on holiday, save toward your child’s education, just for a rainy day, protect and secure capital?
When do you want this goal to be achieved?
Which investment strategy should be employed to reach it in that time; a preservative one, protective, growth, cautious, moderate, moderate-aggressive, aggressive growth? Time and strategy will always be connected.
Our other savings
It is important to try to have the investment goals we set, align with our financial position. Taking ‘life’ into consideration, staying committed to a five-year investment plan might be rather difficult if we have no alternative savings to cater for emergencies that may take place in those five years. Ensuring that we have sufficient alternative savings to cover unexpected short-term expenses is an important part of getting the most out of our investment growth.
Our need to withdraw
Every investment has a time horizon attached to it because of the strategy behind it. Withdrawing before that time horizon can result in us as an investor not experiencing the full performance returns of that strategy. When assessing risk, it is important to ask ourselves honestly if we will need to withdraw from the investment before the specified time horizon. Although we can freely withdraw, it may not be beneficial.
Be vigilant when assessing and considering investment risk. Rather, make sure that the investment options you choose will effectively address your own unique needs and investment goals. Once you have an investment plan in place, stay disciplined, be patient and go enjoy your family and friends.
– Cephas Dube, Johan Steyl & Kheara Lugg