Tailoring a sound investment strategy can be complex but if the emphasis is on buying high quality assets with dependable characteristics, having a diversified portfolio and prioritising liquidity, the fundamentals of any portfolio should be sound.
These are uncertain financial times. We are on the tail end of one of the worst recessions in history. Currencies are being tightly controlled by central banks. Geopolitically speaking, there is conflict in many parts of the world. In short, there are a lot of uncertainties influencing anyone’s ability to make sound decisions on where to put spare money.
The most important exercise for any investor to undertake is to make a plan based on their capacity to make savings and their own personal objectives, timeframe and risk tolerance. As future events unfold the plan should be reviewed to ensure that it remains appropriate.
“The starting place is to consider what the investments are likely to be needed for and to anticipate when they will be needed,” says Munro O’Dwyer, director at PwC. “The investment allocation decision on an investment that can be made over a 10-year or more period is very different from the investment allocation decision on money that may be required in the relatively short term.
An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because they can wait out the ups and downs of financial markets.
“A second key element is the ability and willingness of an investor to put their original investment at risk in exchange for greater potential returns, their “risk tolerance”.
Investors should reflect their personal risk tolerance in the investment decisions that they make – and risk tolerance will vary over time, as an individual’s age, employment and wider personal circumstances change.”
Equities, bonds and cash have typically been the building blocks of any investment strategy. But Irish investors have always preferred property too.
“The challenge with property, however, is that it requires a significant level of capital and as a result can form a disproportionately high part of an investment portfolio,” says O’Dwyer.
“Diversification is absolutely important, particularly from an asset allocation and geographical exposure perspective,” explains Cedric Creuss Callaghan,
director at Smith and Williamson Investment Services.
“We prefer liquid assets, anything we own has to be convertible into cash within a five-day period. In the current climate we don’t want to lock our money away for any period of time.”
Liquidity
“Liquidity is very important as it allows you to react to market conditions swiftly. Every thing has to be convertible, that’s our principal,” he adds.
“In the markets at the moment, there is a divergence in monetary policy, between the UK and US who are both starting and finishing quantitative easing (QE). This must be considered when choosing where to invest. Plus you have the various geopolitical concerns, such as the conflicts in Ukraine and the Middle East.”
The biggest issue right now, according to many commentators, is that euro zone is caught in a “deflationary vortex”. “One of the key driving forces for any investment’s fortunes is the pan-macro economic environment,” explains Ian Quigley, head of investment strategy at Investec Ireland.
“It’s difficult for savers right now because of low interest rates. But interest rates are going to stay low for a very long time. There is a need for the inflation rate to stay low.
“A couple of things can happen after a financial crisis, what’s known as the Minksy Moment, when there is too much debt. After the 1920s, there was too much debt, and that debt grew faster than income, so they let the system go, and the following wave of bankruptcies led to the Great Depression, which was exported across the world.
“There was a similar build up in debt after World War II. Now governments are taking a reflationary response: the US government is issuing bonds, and doing things like QE.
“Our experience with clients is that if you had a very high cost of borrowing along with very high levels of debt, that’s not going to work out well in the long run. Irish borrowing levels were unsustainable, but were still in the strong currency area. So if you want a return, you need to invest in assets that deliver sustainable gains and avoid speculative risky ventures.
“Buy high quality assets with dependable characteristics, equities with dependable earnings, and cash flows and dividend yield. That has always been guiding principles of ours,” says Quigley.
Too much cash?
So what is happening for those who are holding too much savings in cash? “Most investment markets have experienced quite strong positive performance – equity markets, bond markets and property – over the past three years,” says O’Dwyer.
“For investors who have remained in cash they will have forfeited the opportunity to participate in gains, preferring the capital security that cash offers. A key consideration for these investors is in relation to how long they intend to hold cash, as while cash offers capital protection, it does not offer protection against the effect of inflation. Holding cash over long periods can see the purchasing power of that cash decline, meaning that it loses its value in real terms.”
“Cash won’t give you a return but it will afford the flexibility to buy assets if they get cheaper,” says Quigley.
“It makes sense to have some cash within an overall asset allocation and try to work out what is the right amount of different asset classes required to form a solid financial portfolio. But it’s also about what you can tolerate. You need to work out what is the amount of money you should have to keep you comfortable.”
Tax
Tax implications of any investment or savings strategy must also be top priority. Those who box clever, from a tax perspective, can save significant amounts. “Tax is a key consideration in any investment decision,” says O’Dwyer.
“For example, pension savings offer a tax effective way to save – as investment returns earned are free from any tax. There is also tax relief provided on any contributions made, albeit pension investors will pay tax when they ultimately draw down the benefit.
“For other non-pension investments, the taxation that applies is generally 41 per cent on deposit interest earned or on gains made on life assurance or investment funds.
“Gains on direct equity investments incur a Capital Gains tax charge at 33 per cent (each individual has an allowance of €1,270 each year – gains of this amount are not subject to CGT). Where an equity holding is disposed of at a loss, these losses can be offset against any other capital gains.”