Most investors recognize and understand the risks involved when investing. However, during times of extreme market decline, even the toughest investors’ risk tolerance is tested. Such dramatic downturns can force many to limit their risk exposure. But, regardless of market highs and lows, investors really need to maintain perspective and proper risk to pursue their long-term financial goals.
“Low risk” investments help protect one from a decline in the overall stock market, but might leave one exposed to other risks not seen on the surface.
Risk #1: Inflation cutting your real return
After subtracting taxes and inflation, the return one receives from a low-risk investment may not be enough to remain ahead of inflation.
Risk #2: Limiting your portfolio’s growth potential
Beware, some portfolios with low-risk investments may be riskier than one realizes due to the limited growth potential of these investments.
Risk #3: Your income can drop when interest rates drop
If interest rates have dropped by the time a low-risk investment becomes due, one might have to reinvest at a lower rate of return, resulting in a lower yield each month.
A properly constructed portfolio with the correct balance between risk and return will mitigate the risks of market volatility. When deciding on how to invest, it is important for investors to take into account their personal attitude to risk and capacity for loss but also to understand the performance characteristics of different blends of equities and bonds and in particular, how their own portfolio might behave. This will ensure that when markets perform in a particular way, investors will appreciate that this is within the range of possible outcomes for their portfolio.
This is where an independent financial adviser can help by guiding investors to the correct choice of portfolio, which has the best chance of helping them achieve their goals. They can also help educate investors so that they better understand what to expect and encourage them to adopt a disciplined approach.
The financial media recently has been consumed by the issue of ultra-fast computer-driven trading and what it might mean for ordinary investors. But arguably what does the most harm to people are their own responses to high frequency news.
The growth of 24/7 business news channels and, more recently, financial blogs, Twitter feeds and a myriad of social media outlets has left many people feeling overwhelmed by the volume of information coming at them.
The frequent consequence of the constant chatter across mainstream and social media is that investors feel distracted and unanchored. They drift on tides of opinions and factoids and forecasts that seem to offer no single direction.
The upshot is they end up second guessing themselves and backing away from the resolutions they made in less distracted times under professional guidance.
Remonstrations by advisors can steer them back on track for a little while, but soon enough, like binge eaters raiding the fridge, they’re quietly turning on CNBC and opening up Twitter to sneak a peek at what’s happening on the markets.
Quitting an ingrained habit is never easy, particularly when asked to go cold turkey. But there are ways of gradually weaning oneself off media noise. And one idea is a “seven-day news diet” that eliminates the distractions a little at a time:
Day: 1 Switch off CNBC. Business news is like the weather report. It changes every day and there’s not much you can do about it. If you really want drama, colour and movement, stick to Downton Abbey.
Day: 2 Avoid Groundhog Day and reprogram the clock radio. Waking up every day to market headlines can be more grating than Sonny and Cher.
Day: 3 Read the newspaper backwards. Start with the sports and weather at the back and skip the finance pages. Small talk will be easier, at least.
Day: 4 Set up some email filters. Do you really need “breaking live news updates” constantly spamming your inbox?
Day: 5 Try “anti-social” media. Facebook is great, but it’s like a fire hose. If you want to be social, pick up the phone and ask someone to lunch.
Day: 6 Feeling the pangs of withdrawal? Go to the library and look up some old newspapers. They can give you a sense of perspective.
Day: 7 You’re nearly there. Use this window to decide on a long-term financial media diet. You might decide to check the markets once a week, instead of once a minute. The important point is to have a plan.
Those who swear off the financial media, if only for a little while, often find they feel more focused and less distracted. The ephemeral gives way to the consequential and they come away from the hiatus with a greater sense of control.
Any changes they make to their investments are then based on their own life circumstances and risk appetites, not on the blitzkrieg of noise coming at them minute to minute via media outlets.
Ultimately, going on a news diet can be about challenging our patterns of consumption and thinking more intently and less reactively about our decisions.
We can still take an interest in the world, of course, but at our own pace and according to our own requirements, not based on the speed of the information coming at us from dozens of gadgets.
In the words of the American political scientist and economist Herbert Simon “a wealth of information creates a poverty of attention”. So it follows that if you economise on your information diet, you can maximise your attention.
Most investors are aware that their funds levy annual charges against their funds. These comprise the Annual Management Charge which ranges from 0.1% to around 1.8% or more for UK mutual funds. In addition the funds are required to publish certain additional fund charges such as custody and legal costs. These two items make up the Total Expense Ratio (TER).
Many investors are unaware of the fact that, in addition to the TER, funds incur costs in two other ways. One of these, the Portfolio Turnover Rate (PTR), is caused by the costs which fund managers incur when the buy and sell stocks. The more they do this, the greater the PTR. In the UK the estimated cost of a sale and purchase is around 1.8%, when Stamp Duty is taken into account. The average UK fund turns over its portfolio by around 100% a year, thus adding around 1.8% onto investors’ costs. Many funds have PTRs of twice or more this level.
A further area in which investors can incur costs is the price at which funds are able to deal in their shares. Generally shares are offered for sale or purchase by market makers in batches of say, £250,000 or £1Million. On dealers’ screens the best priced batches are generally shown at the top of the list with prices getting worse further down the list. A fund needing to offload £10Million of a particular stock could therefore find its self selling via a number of market makers and not all at the best price available on the market. This can be a substantial hidden drag on fund performance, especially for very large funds or those which trade actively.
So what can be done about this? Bearing in mind that the method of access to the market (fund selction) is very much a secondary decision, well behind Asset Allocation, the optimum way to keep fund costs down is to invest in passive or tracker funds. These can be expected to provide returns in line with the performance of the market at low cost. In addition certain passive funds engage in dealing strategies designed to optimise the price at which deals are carried out.
New guidance has been issued by the Solicitors’ Regulation Authority (SRA) stating that Solicitors must not refer clients to tied or multi-tied advisers; i.e. advisers who are not truly independent.
The SRA has stated that it is aware that some law firms have been approached by multi-tied and tied advisers seeking to enter into restrictive arrangements to provide financial services to the law firms’ clients. It reiterated that firms must always act in the best interests of their clients. This means that they must refer clients to independent financial advisers for investment advice.’
According to Sifa (the body representing independent financial advisers who specialising in working with law firms), there is confusion among solicitors about the status of financial advisers and this has resulted in widespread breached of the Solicitors’ Code of Conduct. Sifa said it had received numerous calls from IFAs reporting instances of solicitors referring clients to St James’ Place.
So, if you are a Solicitor or indeed anyone seeking financial planning advice make sure that you ask the adviser whether they are genuinely independent. Solicitors can be sanctioned for failing to do so and individuals are likely to suffer from a restricted choice and, in all probability, high charges
The Telegraph on 17th July published a list of tips for investing in a recession, which included a contribution by me!
For top investment tips click here
In summary, my view is to be systematic and disciplined … and keep costs down.
There are essentially two main sources of financial advice in the UK; Independent Financial Advisers and Tied Agents. The key difference between the two is that Independent Financial Advisers are required to act as the agent of the client and to select products from the whole of the market, whereas Tied Agents represent a single financial institution, or at best a limited number of companies. Independent Financial Advisers are also required to offer the option of being paid by a fee instead of taking commission when they arrange transactions on your behalf.
So, what does this matter? After all, both types of adviser put themselves forward as providing comprehensive financial planning, wealth management, tax and estate planning. Some Tied Agents even promote their fund management service as offering a ‘Best of Breed’ – take a look at this Google Search result page for a few examples.
Well, the chances are that you already own products from a variety of companies. Once the financial planning advice has been provided you are probably going to need to acquire some products in order to provide the security that you require and deliver your long term financial goals. With a Tied Agent you immediately encounter a couple of problems. They are not allowed to advise you on the products which you hold with other companies. Just as importantly, when it comes to putting the financial plan into action what choice do you get from a Tied Agent? If you have been following this so far, it will come as no surprise to learn that what you get are products from the companies that they represent.
Suppose you have gone ahead and bought a number of products from a Tied Agent and after a while you decide that their investment performance has not been up to scratch. You go to the Tied Agent and ask him what your options are. He can only offer other fund choices from the provider that he represents.
Independent Financial Advisers, in contrast, can advise on all products that you already hold. If you need to buy new products, they are required to search the whole of the market and recommend the most suitable one for your needs. They are strictly answerable to you and act as your agent and not that of a product provider.
Clearly it is a matter of personal choice. The following table may help you to decide which type of advice is best for you:
If you do decide that Independent Financial Advice is best for you make sure that you check that is in fact what you are getting. Due to the obvious advantages Independence confers on consumers Tied Agents working for ‘Wealth Management’ companies will go to considerable lengths to fudge the issue. Ask them out right whether they are an Independent Financial Adviser. If in doubt check the Unbiased Register to see if their details are included.