Thinkpiece

01 Apr Thinkpiece

In this update: 

• Just because you don’t see the risks…
• Order and Chaos
• Equities
• Emergency Fund

Welcome to this financial planning update. Here we share some views on various topical points relating to financial planning.

Just because you don’t see the risks…

 
I have of course met and advised many people over the years and I am well aware of the different interpretations of risk that people have. However people may define these risks personally, there are unchanging core principles that are inescapable. These are particularly relevant when investing money.

My experiences remind me time and again that all too often people create buffers to the real risks of a particular course of action, ‘turning a blind eye’ and convincing themselves internally that ‘it will all be okay’, or ‘If I take this course of action then I can only win’. This is an imbalanced way of looking at it and completely ignores any potential downsides of a particular course of action.

When you go for a dip in a pond, you need to know what lurks under the surface in order to make sure you don’t get a nasty nip. If you’re doing this in a local swimming pool, then that’s going to be, usually, perfectly fine but subject to the normal risks of swimming. If you are going to go for a swim in the Amazon, this is an entirely different prospect.

All too often, people conflate investment with speculation, merging the two. Investment has nothing to do with speculating. Frequently I see investment and speculation conflated in social media, the press, on the news, and even by the UK regulator!

The individual investor should act consistently as an investor and not as a speculator.

Benjamin Graham

Be careful too, of herd instinct. Following the pack can be dangerous. The herd may end up in the slaughterhouse! What’s appropriate for one person may be completely inappropriate for someone else. Diversity is your friend here, but don’t over-dilute things either.

Take for example property investment, which saw a boom in the early part of this century with the buy to let property movement gathering significant momentum. This is a classic case of one course of action not necessarily being appropriate for someone else. Don’t get me wrong, many people have been very successful with a well-structured, well thought out strategy for building their wealth through property. However, one must have the ‘right recipe’ for what success looks like in any approach to investing. This will include a realistic evaluation of the risks of a particular course of action and the probabilities of the downsides.

Above all, have a clear aim of what you are trying to achieve – see order and chaos below. Sometimes I see people thinking they want to go down a particular path because ‘they can’t lose’ and end up in the place that they thought would help them, only to find that it doesn’t and they haven’t. This can of course take many years to materialise, so be careful what seeds you sow. By the time you have built whatever it is that you thought you wanted, the world may have moved on, and with it, your profits.

Be careful what seeds you sow.

Failing to carefully evaluate the full picture often ends with somebody bemoaning their property or investment portfolio, citing risks that they didn’t foresee, know existed in the first place, or failed to understand.

One other major disadvantage of property investment when compared to investing into funds that each in turn invest into hundreds of companies, is the lack of diversity. Even where you seek to buy several properties, you cannot match the diversity of a suitability constructed investment portfolio. If properly constructed, you’re pitting your property / properties against the might of the best businesses in the world! Good luck!

…oh and be ready to pay tax when you own direct property. The government know that some people love property, so that have their tax collection strategy aligned very well with this. Investment portfolios can often partially or totally held within tax efficient wrappers, making them much more efficient at retaining returns.

This is why professional advice is so important – a trusted sounding board that is unbiased and has no particular pre-conceived course of action in mind. Everyone is different and with it, their own plan and course of action.

Many people quote the hassle factors with property, the unexpected phone calls at inconvenient moments when tenants want ‘such and such’ fixed, and any other multitude of problems including tenant delinquency. This is just one example of what is often overlooked. Yet, a quick look on social media shows it is awash with so called property gurus.  

The lesson then – just because you don’t see the risks it does not mean they aren’t there.

Risk never looks like risk when it’s generating a high return.

Howard Marks

Order and Chaos

 
The now famous Taijitu, a symbol in Chinese philosophy representing Taiji (Tai Chi) indicates two complimentary forces, yin and yang, each with the seed of the other force contained within it. These forces, among other things, have come to represent order and chaos in the Universe, our lives and our fortunes.

I am sure that most people would hope that things remain orderly all the time, but occasionally events beyond our control create chaos and disruption, or outcomes that we hadn’t planned or desired. That’s just part of life.

Life is not what circumstances make of us but what we make of circumstances.

Sri Aurobindo

In financial planning, a structure around our finances can give us that support when things become difficult. The work that one has put in many months or years before can be brought to the fore to help us through the unexpected or unanticipated event. This is like a platform for anything. If you build a house, make sure it is built on a solid platform or else expect some subsidence.

Likewise with our finances. Build a solid progressive platform first and then continue to develop it, typically under the guidance of a professional financial planner, in order to ensure that it delivers on one’s objectives. If we don’t have this, the rug can be pulled from under our feet at a time when we least expect it and our plans are unexpectedly cast aside.

Equities

 
If we imagine that an investment portfolio is like a car, equities are the engine, providing power when it’s needed.

Of course, it doesn’t matter what power you have under the bonnet, at times you’ll be stuck in a traffic jam. This is the same in investment markets. There are times when no matter what quality of businesses you own in your portfolio, the environment or economic conditions are not supportive of a realistic price for those investments. Consequently the engine will be running and costing you money, but it won’t be producing any power.

This is the time that an investor needs to exercise patience.

The stock market is a device for transferring money from the impatient to the patient.

Warren Buffett.

For those experienced investors who are unconcerned by volatility, this is par for the course and completely normal and expected in terms of one’s investments.

For those inexperienced investors, they may be tempted to tinker with their portfolio or switch into other asset classes such as bonds or even cash. This can be incredibly detrimental to one’s long-term ability to build up funds if undertaken inappropriately. Again, professional advice is essential.

We will never know the right time to come in and out of the markets and therefore simply buy and hold. Therefore, don’t even try.

Stocks don’t go up on time. Stocks go up over a period of time.

The real key to making money in stocks is not to get scared out of them.

Peter Lynch

Emergency fund 

 
Part of a well-structured financial plan is having a sum of cash available for any unforeseen emergencies. This could well mean when stock markets correct, prior to which we had been drawing down from our portfolio during a rising market.

Now the strategy should change. We should look to turn off our withdrawals from our portfolio where these put excessive pressure on it during market corrections. We should then turn to our emergency fund to see it through the temporary fluctuation and advance of markets.

Once the markets return to growth, we can then rebuild these reserves from the investment performance that has resulted from us not drawing on our portfolio. Maintaining these pots of money in appropriate proportions is a key tenet of any strong financial plan.

Another important use of an emergency fund is simply for that, emergencies. Housing repairs, family matters and any other number of things can sneak up on us when we are least expecting them. If we have appropriate funds in place to address any immediate financial burden, we then leave our investments doing what they need to do, remain invested.

If we have to interrupt the investment process in order to address the issues at hand, this could impact adversely on our long-term plans.

We cannot time markets. The stock market does not know that you own it. Having these available resources in the background is an important part of one’s investment success.

Summary

• Make sure you understand the risks of speculating and having limited diversity within your investment strategy.
• Develop a robust structure for your finances in conjunction with your chosen trusted adviser.
• Don’t react to volatility. It is perfectly normal….and remember to exercise patience when everyone else is impatient.
• Don’t underestimate the benefits of having an adequate emergency fund.

In bear markets, stocks return to their rightful owners.

J P Morgan

If you’ve not yet put in place a sound financial plan and you’d like to know more, please feel free to contact us on
01626 305318 or via email here.

Best wishes from all at Stover Financial Planners!

The views expressed are not to be taken as financial advice. Professional advice should be sought before proceeding.