The investment world is full of jargon – dividends, price earnings ratios, yields, exchange-traded funds, contracts for difference, bonds, stocks, equities, convertible loan notes, put-and-call options, and that’s just for starters. Entering this strange world with its even stranger language is not for the faint-hearted.
Bank of Ireland head of pensions and investments Bernard Walsh says there are some things more important than understanding the terminology. "The first thing to understand is your attitude to and appetite for risk," he says. "Bank of Ireland takes quite a scientific approach to this and we rate people on a scale of one to seven. The vast majority of people come in at around three or four on the scale."
That means they are neither totally risk averse nor are they wild gamblers. “After that, you need to understand your goals,” he adds. “What are you trying to achieve? If you just want to get your money working for you, there are a few options open.”
The next step is to calculate how much you can afford to invest
He recommends a strategy of dividing money into what he calls “three buckets”. The first is to look after day-to-day spending. The second is for medium-term spending and is the emergency fund to cater for unexpected events which may arise within the next couple of years. “We recommend having three to six months’ income in that emergency fund and it should be kept completely separate from day-to-day spending,”he says. “You have to make sure it’s not dipped into for anything.”
The third bucket is for money which can be invested for the longer term. The target rate of return on this money is critically important and Walsh says people need to look at their own personal rate of inflation when calculating this. “That’s not the official rate but the rate that applies to your spending habits and lifestyle. That could be closer to 5 per cent and you need to be making at least that much on your long-term investments if their value is not to be eroded by inflation. Once you know your target and what you have to beat, you can combine that with your attitude to risk when deciding on your investments.”
And there are ways to manage risk, he adds. “At Bank of Ireland, we have a strategy that adjusts risk exposure in response to market volatility,” he says. “But people need to understand trade-off between risk and return.”
That risk-return relationship is very much to the fore when AIB Private Banking is discussing investment options with customers, according to chief investment officer Philip Kearney.
“We analyse the customer’s circumstances and from that we understand their risk profile, their financial goals, and their return expectations,” he says. “It might seem unusual, but we truly believe that in any investment discussion we must start with the possible downside by appropriately assessing our customer’s tolerance and capacity for loss. Only when we understand and quantify that risk can we legitimately come to a realistic return expectation for the customer.”
Aspirations and objectives
After that comes the customer’s aspirations and objectives. “Before we build a strategy, we also need to consider a myriad of other customer considerations like a need for income, their tax position, their residency, their pension vehicles, their existing assets,” Kearney adds. “Once we have established the customer’s circumstances, we draw down from our framework asset allocation models to determine an appropriate asset mix for the customer.”
These models have been subject to 40-year back-testing by an external party, he adds. “We are very confident of their veracity. I don’t believe the industry standard of showing the last three years’ performance is a proper guide for a customer. The point of our empirical work is to build with confidence a sufficiently diversified portfolio with an appropriate level of rigour. Our aim is to take on the least risk we can for the level of return the customer is seeking.”
Getting the right advice is critically important, of course. “I know a little bit about plumbing, but I wouldn’t take on a job in my house by myself,”says Simon Hoffman, head of intermediary distribution with BCP. “I’ll go to someone who does know about it first and get their advice. It’s the same with investment.”
Choosing the right adviser is also important. “If they are speaking a language you don’t understand, they’re not right for you,” he says. “You want to be comfortable with your adviser.”
And good advice costs money. “People need to understand that free advice has about as much value as what you have paid for it,” Hoffman says, adding that going without advice is not free as it will cost in the end in terms of potential investment missteps. “You have to go in with your eyes open in relation to the costs and make sure the advice is right for you.”
And beware of not-so-gifted amateurs. “If you get a tip from a guy on a bar stool, it has about the same value as a tip on a horse in Leopardstown,” he says. “Of course, people should do your own research but as in any walk of life, it’s better to talk to the experts.”
Finally, there is room for people to take a punt on the markets themselves using investment platforms like Degiro but this should only be done with spare cash that might otherwise be spent on leisure or entertainment. “If you want to dabble in DIY investments, do it with fun money,” Hoffman advises. “You can have a pot of money for investments of this type, but it has to be money you can afford to lose. If losing that money would cause difficulty, you need to talk to someone and get advice.”