Diversification in investing is vital according to the experts, however, they also suggest a strong inclination towards stocks is beneficial for long-term asset growth, given that you’re alright with some fluctuations. The conventional notion of moving investments from stocks to cash as retirement approaches is no longer considered the best method due to changes in pension regulations.
According to Ian Quigley, the head of investment strategy at RBC Brewin Dolphin, understanding risk tolerance is critical in devising an appropriate diversification plan. There is no universal investor profile, he stresses.
“It all boils down to individual investment aims and the ability to endure occasional financial instability or transient loss,” he emphasises. Market fluctuations of 10-20% are not uncommon, along with significant financial crises events, which are expected in an average investor’s lifetime. Grasping how well you can handle these circumstances both monetarily and behaviourally is of paramount importance.”
Investors should think beyond the immediate fear of a 20% portfolio plunge and decide whether they could withstand such downturns and stay invested, otherwise, a shift to a safer asset class could change a passing setback into a lasting one.
Despite the inherent instability, Quigley asserts that all historical data indicates that in the long run, stocks outperform all other asset classes. Therefore, if a mid- to long-term investor wants to maximise their return, they should have a significant proportion of their investments in shares, assuming they’re able to tolerate transient losses.
An approach known as “dollar cost averaging” allows investors to contribute constant amounts to a fund on a routine basis- like a monthly deposit. This helps them capitalise on both highs and lows, purchasing fund units at varying price points, thus minimising the volatility effect.
“The cumulative return from equities has been roughly 6 per cent above inflation,” says Quigley. He adds, “Today’s starting point may result in lower-than-usual yields, around 5% post-inflation seems more realistic. Although it may seem slight, it can accumulate substantially over time.”
Quigley states that maintaining cash assets or investing in few government bonds that match inflation might seem more feasible to some investors, despite the long-term devaluation of such assets. Sometimes, prefering stability over maximising returns is a subjective matter for investors. Options available for investment include cash, government bonds, corporate bonds, which are essentially loans given to either governments, banks or companies for a certain return. Such diversifications offer guaranteed, albeit nominal, returns. At present, the German ten-year bond yield is roughly 2.3%, slightly below inflation, while premium corporate bonds might offer slightly higher returns.
Real estate is another viable investment avenue. Real Estate Investment Funds (REITs) have seen a surge in popularity in recent times. Additionally, one can invest directly in property using pension funds, but one must be mindful of the added risks and responsibilities of owning and managing the property.
The length of investment holds great significance and this is emphasized by Niall McGrath, PwC’s Pension Practice Director. He maintains that for investors whose timeline is less than five years, safeguarding the capital is crucial, hence cash and similar assets are suitable choices. For an extended timeline, greater volatility can be tolerated as recovery periods compensate for declines.
McGrath elaborates that for many, the words ‘risk’ and ‘volatility’ are interchangeable in the context of investment strategy. Nevertheless, accepting a degree of risk can pave the way for better anticipated returns. He stresses the importance of timing, and the potential of needing to unexpectedly liquidate the investment. Thus, for medium to long-term commitments, he emphasises the risk lies in how inflation can diminish the buying power of the investment. Therefore, he advises clients to devise strategies that allocate resources to real assets like equities and property.
Concurring with Quigley, he professes that recognising an investor’s tolerance for risk is crucial, adding that those who have a long-term perspective should consider channeling almost all of the resources to growth assets such as equity and property.
McGrath suggests that diversification is crucial within different asset types such as small and large cap equities, industries, and regions. Concentration risks have become apparent in recent times due to the performance of a handful of tech stocks based in the US.
The evolution of pensions necessitates the diversification and mitigation of risks in investment funds, according to Cian Morrissey from Morrissey Wealth Management. He adds that traditionally, when pensions matured, individuals used to purchase an annuity with those funds which assured a certain income for life, based on the value of the fund. As such, reducing risk before retirement was vital as a fund’s dip could substantially diminish retirement income.
However, Morrissey adds, nowadays, upon retirement, people generally take their tax-free lump sum and the balance usually goes into an Approved Retirement Fund (ARF) where their pension remains invested. Individuals must withdraw a minimum of 4% per annum the year they turn 61 and 5% from when they turn 71. The aim is for investment performance to exceed this.
The use of ARFs, he observes, has often seen individuals who began a pension at age 40 intending to retire at 65, not even halfway through their investment journey. Hence, mitigating risks should not overshadow the need for continued and future growth.
An investment fund with multi-asset platforms, offering a combination of equities, property, bonds, and cash, could be a suitable diversification pathway. Morrissey often suggests clients divide their investment between two different life companies, reducing asset manager risk and allowing for funds to be invested in different sectors/locations, and with a different asset balance.
Irrespective of the asset class, McGrath advises investors to frequently connect with their advisers and consistently re-evaluate their decided investment strategies.
This approach permits adaptations accounting for variations in personal situations or changing perspectives on investment peril. It offers a chance to think about the efficacy of an investment collection and assess its performance. Additionally, it is crucial to determine the optimal way to prevent unwarranted interventions and ensure that portfolio evaluations result in specific measures.
When deliberating over a broadening stratagem, an evident fact is the persistent growth in life expectancy witnessed over time. If investors desire to live comfortably through their prolonged retirement, their investment techniques must bear this in mind. It is essential to include assets capable of producing returns that outpace inflation.