20 December 2017

Alec Berry

Client Adviser - Wealth Management

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In the post-GFC world, where central banking policy has forced interest rates to historic lows, we find ourselves in a period of artificially inflated investment markets (across the board), with hasty interest rate increases over the short-term very unlikely. With cash and term deposit returns falling short of investors’ needs, many are turning towards riskier investments in their chase for higher returns, and understandably so (Bitcoin, anyone?). While this can be very tempting, higher returns generally come with higher risk. Like we’ve said before – yes, you could win big. But you could lose big, too. The collapse of Nant Whisky is a prime example.

But there are alternate options.

In our opinion, and that of many asset managers and market commentators, the investment return outlook is relatively subdued for the next five years following a strong post-GFC rally. This means that now might be an ideal time to take advantage of alternative strategies available to you. So, before diving into 2018 and investing in riskier investments in the hope of gaining those higher returns, now is a good time to consider what other options you have on the table.

 

Pay off non-deductible debt

If you have excess cash available and are unsure whether to invest it or use it to pay down “bad” debt (such as home loans, car loans, credit cards), it may be worthwhile taking advantage of the current low-interest rates and dedicate it towards the latter. Whilst interest rates are sitting at such lows, now is an ideal time to pay off your loan principal and get ahead on your repayments (and ultimately gain a risk-free return). Debt reduction is not typically viewed as a ‘return’ but if you think about it, every dollar paid off your debt effectively ‘earns’ the interest rate which you would have had to pay over the balance of the term. As the saying goes, “A penny saved is a penny earned.”

 

No bad debt?

If you don’t have any non-deductible debt, then why not consider building yourself a strong foundation for your future? Today’s current environment, with inflated asset prices and a potentially low return outlook, paves the way for heightened risk and increased uncertainty. Depending on your current situation and what you’re hoping to achieve down the track, it may be worth covering off some of your more conservative goals. For example, we strongly encourage clients to set up an emergency fund and provision for their other savings goals (such as travel, children’s education, a car upgrade or home purchase). The sooner you get your financial strategy bedded down, the better off you will be in the future. Once you’ve got this sorted, you can look at different investment options for any surplus.

 

Investment considerations

If you’re on top of your game and you’ve got the above sorted and are considering investing your excess cash, then make sure you understand your timeframes for investment. Once you are across this dynamic, you need to understand how to get money invested and what style of investment you wish to adopt.

 

Entering the market

Let’s say you have some excess capital you are looking to invest. Typically, there are two strategies you can employ – going all in and putting everything into the market at once (lump sum investing) or investing a fixed amount of this capital over a defined period of time (say 12 months), no matter what the market is doing (dollar cost averaging). There is research that suggests, on average, lump sum investing has historically been a better strategy than dollar cost averaging as markets tend to rise over time. This Vanguard research is an interesting read – though quite technical.

However, there are a number of factors that need to be considered such as the type of investor you are, your tolerance for risk and what you’re trying to achieve from your investments. For example, it’s important to understand how you might react in a scenario where you have made a lump sum investment and your portfolio immediately drops in value following a market downturn. It may be prudent to adopt a strategy which mitigates poor decision making when markets take a turn (i.e. selling investments due to a short-term fall in prices) and a dollar cost averaging strategy may be appropriate to overcome this common behavioural pitfall.

It is important to note that the above is referring to the investment of a lump sum rather than any regular surplus funds (such as monthly savings) where dollar cost averaging, in our view, is a sensible long-term strategy.

 

Active vs Passive

While there are varying definitions of passive and active management, passive management is essentially investing in an index of assets (e.g. S & P 200) with limited buying and selling within portfolios. Active management is a more hands-on approach which requires expertise in knowing what companies to own and when is the right time to enter and exit these companies. In our view, there’s no clear right or wrong answer when it comes to active vs passive. They both have their merits and can work well together in a portfolio.

You can spend weeks reading up on the potential pros and cons of the opposing investment approaches articulated by incredibly smart minds, but at the end of the day, the more important point is to actually start investing and take advantage of compounding returns (so long as you have a sound long-term investment strategy in place and know exactly what you’re trying to achieve from your investments) rather than sitting on the sideline waiting.

 

Investment Structures

It is also critical that you understand the various investment structures available and the associated tax consequences as this can have a significant bearing on long-term net return outcomes. Just as paying down debt should be viewed as a return, so should tax minimisation.

 

So, what next?

We understand that the various options available to you can be overwhelming and that it can be tempting to follow the hype and popularity surrounding various investments. Realistically, however, as long as you understand what funds you have available for specific purposes (which can mean spending a few hours thinking about what you really want to achieve down the track), the game is relatively straightforward.

As you prepare to welcome the New Year, put some time aside to make sure you have taken the first few simple steps in bedding down your financial foundation and mapping out a strategy unique to you. Understand your cash flow strategy and automate it. Provision for emergencies and save for your defined goals (which might include debt reduction). Understand your options for investing and set up a regular investment plan with any surplus. Ensure you minimise tax along the journey. It’s all relatively straightforward in theory when you know exactly what you want to achieve, however, as with any successful diet plan or fitness program, discipline is key. If you’d like to have a chat with us about any of the above, or your financial situation in more detail, please get in touch to organise a complimentary consultation.

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.