PLANNING POINTS
By Ryan McCaughey
This month, I’ll focus on an optimally-structured investment portfolio, and will go into detail about the importance thereof, and the benefits it can have for you throughout your financial journey.
The local and international investment environment is particularly complex. It subjects investors to a myriad of alternative investment products and structures that invest in a broad range of asset types, each of which have very specific risk, return, term, taxation, and regulatory and legal characteristics.
There are five key areas of focus:
1. Understanding your risk tolerance.
2. Optimising your investment term and return expectations.
3. Establishing an investment portfolio that is optimally-structured, taking diversification and costs into account, and structured to avoid unnecessary taxes while considering all regulatory and legal characteristics.
4. Implementing your investment structure.
5. Reviewing your investment structure regularly, and making changes where necessary.
Engaging the services of a Certified Financial Planner can assist you on all of the above fronts.
Identifying your risk tolerance
This is one of the most important things to consider when creating your investment structure. Your risk tolerance is your ability and/or willingness to take on market risk. In short, it’s your ability and/or willingness to accept market volatility in exchange for the possibility of earning higher investment returns.
Factors that play a role in identifying your risk tolerance include your age, investment goals, income, asset base, and your investment knowledge. The predefined risk categories are: conservative, moderately conservative, moderate, moderately aggressive, and aggressive. As you move up the risk scale, you substitute capital protection and income generation for a higher level of capital growth.
Identifying your risk tolerance will help you plan your entire investment structure, and will drive how you invest.
Diversification through asset allocation
Diversification is the cornerstone to investing for the long term: we all know the age-old saying, “Don’t put all your eggs in one basket”.
Diversification reduces the overall volatility of your portfolio. It can take on many forms, and it ultimately relies on your risk tolerance. For example, if your risk appetite is high, you would be diversified within various equity investments available to you. In this case, your diversification strategy would entail an allocation across regions, sectors, indices, and styles (for example, value versus growth), while capturing market-like returns over the long term.
It’s important to understand that a well-diversified portfolio will never outperform the best performing region, sector, or style. It will, however, provide protection to the downside, and achieve your ultimate goal over the long term.
Investing in a tax-efficient manner
Maximising returns often complicates your retirement plan when the time comes for you to start drawing a retirement income. An important consideration when building your nest egg is maximising after-tax returns – ultimately the net portfolio is what you have available at retirement.
You need to consider your options when allocating your investments – for example, housing the investments in their personal capacity (keeping your tax bracket in mind), or splitting them across various products and entities. The same goes for investing in assets that produce interest versus capital growth.
Options include: tax-free savings accounts, various retirement products, life-wrapper investments, establishing a company or trust, and donations to a spouse, to name a few.
These will all allow you to compound your savings at a higher rate, or alternatively structure your estate so that you can draw a retirement income in the most tax-efficient manner.
Implementation and review process
The implementation of the longer-term strategy, underpinned by a rigorous ongoing management and review process, ensures that the expected outcomes are continually adjusted for changes in personal circumstances and market conditions.
Given the current economic cycle, it’s important to prepare for an inflationary environment when establishing or reviewing your investment structure. Five key points to consider are:
1. Asset allocation is key.
2. Pricing power is important when identifying companies to invest in.
3. The inflationary environment affects real returns.
4. Timing the market should be avoided.
5. Being long-term focused is key.
New year brings new opportunities
It’s critical to ensure that your asset allocation takes account of your tolerance for risk, your short-, medium-, and long-term needs and objectives, and that you stick to your long-term investment strategy through market cycles.
Next month, I’ll continue to offer my perspective on a sound financial plan, focusing on the importance of fiduciary planning such as wills, trusts, and estate planning.
I end with a quote that resonated with me while reading many articles over the holidays. “To give anything less than your best, is to sacrifice the gift.” – Steve Prefontaine.
Ryan McCaughey is a Certified Financial Planner at Hewett Wealth and the Financial Planner of the Year 2021/22.