He is risk-averse and likes having cash, so he is happy to forego superior returns to sleep better at night. His portfolio is not perfect, but it suits his needs. That’s what’s important. There’s no one-size-fits-all solution. And, more importantly, a portfolio needs to evolve. As an investor’s needs evolve over time, so must their financial plan and portfolio.
The investing journey can be split from a volatility perspective. How much volatility an investor is willing to assume will probably change over every life stage. For young investors, volatility isn’t their enemy, it’s their friend. When starting out, young investors can afford to assume above-average volatility because their risk of capital loss is lower, and they have the advantage of time to continue investing, which compounds over time. They can even benefit from market downturns, by investing when others are exiting.
On the other side, when an investor starts to near retirement, volatility becomes undesirable and could negatively affect outcomes in the next phase of the investment journey.
So, those are the two opposite extremes. Ultimately, in every phase of the journey, investors must be deliberate about what they want, and how their portfolio must work to make that happen.
Here’s a breakdown of what portfolio building in each life stage could look like, and how financial plans can be adjusted to maximise the potential of each stage for the investor.
This phase is all about saving and wealth accumulation.
During the earlier phase of the investing journey, some managers use a process called mean-variance optimisation. This means measuring an asset’s volatility against its likely return, as well as correlation to other assets in a portfolio – taking into consideration the investor’s risk profile – how much risk they’re willing to withstand – and how much time they have on their side to weather market conditions over time. As younger investors, this group can afford to be more aggressive.
Today, we see many 20-somethings putting their money into cryptocurrencies, tech stocks, innovation stocks, or something equally ‘bold’. While these may be speculative in nature, the desire to bear risk could also be beneficial within retirement savings vehicles like a retirement annuity, or long-term savings vehicles like a tax-free savings account. The attitude to take on volatility can work in their favour, but it is also important for them to consider saving longer term in a diversified portfolio, without excessive concentration risk.
In this phase, the financial plan should be designed to encourage investors to start investing early and remain disciplined. The magic of compound interest means there’s a distinct advantage to starting in the 20s rather than the 30s.
The process should also be automated. If an investor sets up debit orders for their investments, their contributions become seamless. ‘Contribute in and compound up’ as soon as possible. That usually leads to a greater success story at the end of the day.
As we move into the middle phase of life, many investors have more detailed financial planning needs. They might buy a property, start a business, marry, have kids, etc. All of these events have different financial needs, from insurance and estate planning to drafting a will.
It’s also a time when an individual could have some stock options in their company or experience a salary bump or bonuses. A larger amount of capital to invest could lead to having more levers of diversification and investment opportunities available, allowing access to additional long-term investments as their savings pool grows – like property, for example.
In this phase, discipline is paramount, as there is a myriad of demands for your clients’ money. They should continue to capitalise on volatility, as there is still a long investment horizon ahead for them. Savings and retirement contributions should also continue to be adjusted with salary increases – and the current inflation basket, to preserve purchasing power. Bonuses – or any lump sums – should be put to work as an addition to the portfolio as much as possible.
As wealth is accumulated, the investor can more easily contribute to causes they care about, for example, investing in climate change funds, or impact investing. The more capital they have, the easier it is to access these opportunities, as the barriers to entry (minimum amounts) tend to be a bit higher. If capital allocation aligns to beliefs, then that usually instils greater discipline. For example, if the climate change fund invested in falls 30%, the investor will probably be more likely to stay invested because there is a greater alignment between personal convictions and investment performance, which may lead to better investor behaviour over time.
In this life phase, investors’ retirement is in sight, and they should start to move from mean-variance optimisation – accepting a certain level of volatility – to an optimisation strategy that’s more focused on mitigating against market downsides and losses – to reduce negative outcomes as effectively as possible.
To dampen the downside, some higher returns might also be sacrificed. In a nutshell, at this stage, the goal is to construct a portfolio with diverse, complementary sources of return.
This is a key phase in the financial planning process, with important questions such as – are investors getting the best tax advantages from their basket of portfolios? Are tax-free savings, retirement annuities, discretionary savings, etc., all harmonising together?
The financial adviser’s role is critical, as is a robust investment plan. Investors may also need sufficient liquidity in their portfolio, to cover big expenses such as, for example, a child’s tertiary education, or caring for ageing parents.
In this age range, it’s really about focusing on volatility dampening strategies as an individual moves from contributing to drawing down on their capital. Investors need to be cognisant of sequence risk, as they draw down their savings and ensure their portfolio can produce stable performance, with diverse sources of return.
In this phase, free from the constraints of Regulation 28, investors can also increase their investments in alternative assets, including hedge funds, and private market investments, like debt and equity. These investments seek to benefit from the illiquidity premium associated with alternative asset classes over time. It’s all about deliberately opting for diverse sources of return.
In every phase of life, it is important for you, the financial adviser, to walk the financial journey with your clients, so that as their needs evolve, so does their financial plan and portfolio.
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