WHEN IT comes to saving and investing, your overall objective should be to minimise risk while reaching long-term financial goals. These goals need to include your requirements for income and growth as well as ensuring your money is protected, as much as possible, from inflation, taxes and exchange rates. Contrary to what most people think, the answer to minimising risk is rarely to leave it all in the bank.
Hugh McKee, the retirement director at Prudential, nicely sums up the issues facing retired people: “It is generally accepted that the more risk you are prepared to take, the more return you could receive. Investors want to see their money grow, but not at any price. The risk associated with the potential return must be tolerable to the individual, but the bottom line is that, if you want a better return than inflation, the only way to get it is through investing. Many investors are currently keeping cash in deposit accounts, but when you remove the impact of inflation and taxation on their return, there is a need for their money to be working harder for them.
“For the more adventurous among us, the opportunities for speculative returns will always beckon… However, for the more cautious (the bulk of investors) prepared to learn from the lessons that history has taught us, a broadly diversified, well balanced portfolio should be the core element for savings.”
There are three main levels of diversification you should consider adopting to earn the returns you need, without worrying about taking too much risk or your spending power diminishing over time.
1. Asset allocation
Different assets classes have different risk and return characteristics. Your portfolio should combine them in a way that meets your objectives and need for stability. Asset classes include US equities, UK equities, emerging markets, bonds, gilts, property and cash.
Investing solely in low risk investments will give you lower returns. Taxes and inflation will eat away at much of these returns, making it hard to reach your investment goals. On the other hand, investing solely in higher risk equities exposes you to volatility. But by combining, for example, equities and bonds, you can earn higher returns than you would from bonds alone, but with less risk than equities.
2. Diversifying across styles
The equity section of your portfolio also needs to be diversified, this time across styles. These include growth, value, market oriented, and large and small capitalisation. Styles go in and out of favour and perform differently in different market conditions. It is hard to predict which style will outperform and when the cycle will start and end. Diversifying across a variety of styles means that your portfolio will benefit from any upswings and be cushioned when a style goes out of favour. When it comes to investing in bonds, owning a bond fund rather than individual bonds will provide you with this diversification.
3. The multi manager approach
This third layer of diversification can help increase returns and outpace inflation, at the same time as lowering risk still further. It reduces the investor’s dependence on the success of a single manager and produces more consistent results than traditional approaches to investing.
The multi manager process places assets in any one style with multiple management firms. Managers rarely outperform consistently and they all have their own approach, which works better in some market conditions than in others. Your funds may suffer if managed by just a few managers, even if their past record was impressive when you chose them. Research has shown that today’s top managers are unlikely to remain at the top for more than a couple of years.
The opportunity to have a large number of the world’s leading managers looking after your capital is one everyone should consider. A good multi manager firm will research thousands of investment managers each year and study their quantitative and qualitative characteristics. Once chosen, they are constantly monitored to ensure they stick to their assignment and are replaced where necessary. You will, therefore, always have leading managers looking after your investment. These changes go on behind the scenes and do not affect costs or performance.
Multi manager investing is also tax efficient. Funds can be bought and sold without incurring any capital gains tax. You can also place the investment within a Personal Portfolio Bond, which acts as a tax wrapper, whereby if you do not make any withdrawals, you do not pay any tax and, depending on where you live, withdrawals may be taxed favourably too.
To quote Prudential’s McKee again, “investing is just like life. There will be ups and downs; and if you have prepared for the downs, you can limit the damage, recover and be well placed to enjoy the ups”.
Multi manager investing helps you do just this. It’s an all-in-one solution, which combines diversification, active management and risk control in a simple, tax efficient, cost savings vehicle. The wide range of diversification it offers serves to reduce the risk associated with one market or one fund manager and increases the opportunity to benefit from upturns in different markets around the world.
Combined with appropriate asset allocation, it means that your money will be working hard to achieve your objectives, while you can be secure in the knowledge that you have neither taken on too much risk nor ignored hidden risks like inflation.
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