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Investment Strategy
Sunday, March 2, 2014 - 13:30
Adapt or lose

“Age is an issue of mind over matter,” Mark Twain once declared. “If you don’t mind, it doesn’t matter.”

While this may be true when evaluating the passage of time in your bathroom mirror or when marking a birthday that brings with it a new decade, when it comes to your investments your age – or more precisely, your life stage – matters a great deal.
Says Nick Battersby, Chief Executive: PPS Investments, “Consider two hypothetical investors, both of whom retired at the end of 2008. At the point of retirement, Alice was invested 90% in equities and 10% in bonds. She had seen the equity market deliver strong returns over the preceding number of years and had wanted to secure these returns in her retirement portfolio.
“Brenda, on the other hand, had been advised by her financial intermediary that while equity investments are likely to deliver the highest returns in strong markets, they are also likely to result in the greatest losses when markets fall. As she approached retirement she had therefore opted for a lower-risk investment strategy and had invested in a diversified portfolio with a 20% allocation to equities, a 40% allocation to bonds and a 40% allocation to cash.”
Unfortunately, the global financial crisis set in shortly before the investors retired and stock markets around the world registered significant value declines.
Assuming each investor’s portfolio was valued at R1m at the start of the year, the make-up and outcomes of these two investments upon retirement are summarised below:

The calculation is based on 2008 returns of the ALSI (equity), ALBI (bond) and STeFI (cash) indices.
Alice’s portfolio, which was heavily invested in the local equity market, would have suffered a substantial loss of almost 20%. Brenda, however, had reduced the risk in her retirement portfolio by reducing her equity exposure and investing in a more diverse mix of assets. Her portfolio was cushioned against the financial crisis and the value of her retirement savings increased by almost 7%.
Alice, had she remained fully invested post retirement, may have been able to make up her loss over time. However, as she required part of her savings to fund immediate retirement expenses, a portion of the loss she incurred would likely not have been recovered.
“Take your personal circumstances into account,” says Battersby. This illustrates an important principle. When making and managing your investments, it is essential that you consider your personal risk profile, taking your investment horizon and tolerance for risk into account.”
When considering whether your investment portfolio remains suited to your risk profile, there are three key factors to take into account:

1. What is your risk tolerance?
All investments carry a certain degree of risk, and higher-risk investments generally also result in higher long-term returns.
Equity is recognised as the asset class likely to deliver the greatest long-term growth. However, this brings with it the highest level of short-term volatility. This means that while an equity investment may experience several ups and downs over shorter periods, these fluctuations tend to smooth out over time and generate solid returns over longer periods.
In contrast, cash is regarded as the safest asset class. This means that while cash will offer you more muted returns, it also offers better protection against substantial capital losses.
Property and bonds lie somewhere in-between the two on the risk/return spectrum.
When allocating your investment between the various asset classes, you need to determine your ability to cope with a large investment loss. If you have the time to make up such a loss, you may be comfortable to take on additional risk in return for greater potential growth over time. However, if a large loss will significantly erode the final outcome of your investment, you may not have the tolerance to take on such a high level of risk.

2. What is your main investment goal?
Are you focused on growing your savings and building up your capital? Or is your primary concern the preservation of your capital, or the need to draw an income from your investment?
If you are still building up your savings, you may choose to include a more significant exposure to equity in your investment portfolio. However, if you will soon need to utilise or draw an income from your accumulated savings, your focus may shift to capital preservation.

3. How long do you have left to invest?
Short-term market fluctuations tend to smooth out over time. If you have a long enough investment horizon ahead of you, you may therefore benefit from a significant exposure to equities as this is likely to lead to greater long-term growth.
However, it is important to remember that when short-term market losses do occur, it may take up to several years to recover. Should you not have very long to invest until you need to utilise your capital, it may therefore be appropriate to opt for lower equity exposures.
“When making your investment decisions and reviewing your investment portfolio to ensure its continued suitability, it’s important to take a holistic view (and to consult a qualified intermediary if you are uncomfortable making these decisions on your own). After all, as we adapt to our changing circumstances, so too should our investments,” says Battersby.

Copyright © Insurance Times and Investments® Vol:27.2 1st February, 2014
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