18 November 2015

John Barton

Director & CEO

In Part One of our discussion on reframing we considered the benefits of thinking about your income as an asset. Turning now from income to your investment assets, it can be equally valuable to reverse your thinking when it comes to your personal balance sheet.

 

What are your investments doing for you?

Instead of thinking about your investments in terms of their market value — how much you are worth. Try thinking about your assets in terms of their ability to produce an income for you — what lifestyle your assets can sustainably fund.

Generally when people consider their investments, they frame their answer in terms of their net wealth. How much money they currently have. What their portfolio is currently worth. Many investors actually walk around with this number in their consciousness — thinking of it, in some ways, as part of who they are.

The key problem with this framing is that by focussing on a single (market linked) number, investors are much more likely to be troubled by short-term (market) fluctuations and negative (market) commentary. Thinking about your portfolio as an asset that is ‘at-risk’ ensures your subconscious is focussed on the downside. Just like the earlier highly simplified example, this way of framing the situation makes investors more likely to be risk averse, more likely to overreact to short-term issues and less likely to balance their thinking with a sensible long-term perspective.

If, on the other hand, investors focus on the ability of their assets to earn an income, they become more likely to take a balanced perspective. A well-managed portfolio, that is aligned to an investor’s cash flow needs and spending priorities, is highly likely to be able to produce a reliable income stream across multiple years regardless of short-term fluctuations in capital value. This approach enables an investor to focus on risk-adjusted returns and total, after-tax returns. It also ensures that unnecessary and unrewarded risks are less likely to be taken, protecting and preserving investor capital.

So, what level of income are your assets able to provide to you and your family? And, what level of income do you need to achieve your level of independence? The answers to these questions are harder to determine than the income arithmetic we considered in Part One. In fact, you may find it valuable to review these questions with the assistance of a suitably qualified adviser and some appropriately detailed cash flow and portfolio modelling. However, knowing these numbers will provide clarity and set you on the path to sustained financial independence and a more relaxed, confident financial life. Once you know these numbers, you’ll likely start thinking and feeling a little differently about your investments.

Having realised the income (and therefore, lifestyle) value of your assets your number one action should be to ensure that your portfolio is constructed and managed with your liabilities (future cash flows) in mind. This approach will ensure an adequate consideration of your short-term income needs as well as your longer-term needs to protect your future spending against inflation. Your asset allocation — across cash, annuities, property, bonds and equities — needs to align with your short, medium, long-term and aspirational needs. By doing so, you will minimise the prospect of a forced sale of assets at an unfavourable time. You will also focus your thinking on the lifestyle upside of your portfolio rather than being drawn into the never-ending barrage of self-serving media and ‘expert’ commentary dissecting daily market machinations.

Take the time and make the effort to frame your investment portfolio as a source of income and you’ll have the benefit of your expenditures being fully-funded and be able to confidently take control of and enjoy your future.

Disclaimer: This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.