3 questions to ask yourself before you build your investment/pension portfolio

Posted 27 Jul 2017 by Alan McCarthy

Your financial future is not something to be left to chance. It demands a well-constructed, goal-oriented investment portfolio.

In a world of increased market risk, policy uncertainty and an outlook for lower long-term returns across asset classes, how well you build your investment portfolio matters like never before. It can mean the difference between a comfortable or a compromised retirement.

Contrary to common belief, portfolio construction is not a simple matter of choosing asset classes/securities—stocks for growth, bonds for income—and assigning some mix of the two. It’s important to understand how the various components work together, how they might be expected to perform over a given time horizon, the correlation between them and what risks might be embedded in them.

3 questions you should ask yourself before you start on the process of constructing a portfolio that can address your financial needs and goals.

  1. What am I investing for?

This statement may seem obvious, but many investors fail to orient their investments by objective.

To begin, assess: (1) how much you have, (2) how much you need at some point in the future, and (3) how much your investments need to earn.

The tougher question: Is my objective actually achievable? In other words, is that required rate of return possible given the timeframe and expected market conditions you are working under? Consider: How probable (or improbable) is it, and how much risk might you need to take in order to pursue that return. Ultimately, the answers to these questions will help you understand if your goal is a reasonable one, or if your timeframe or expectations may need to be adjusted.

  1. What type of risk am I able and willing to accept in pursuit of those goals?

In the industry, we often quantify risk as a mathematical concept, such as standard deviation. But we are keenly aware that, for investors, risk is emotional. And that can be hard to plan for.

Often, the framing of risk can make all the difference. Imagine that a €100,000 investment in an asset with an annualised level of volatility of 10% could easily undergo a drawdown of €10,000 in any given year. Assessing your tolerance for risk and capacity for loss, if any, is probably not about whether 10% volatility feels OK to you. It’s about the more tangible question: Can I bear a loss of €10,000 in value of my investment at any moment in time?

Equally important: Know the risks you are taking. Nothing removes the emotion from investing, but having confidence in what you have built can sometimes help you to stay the course and not let stressful periods derail the pursuit of your goals.

  1. What am I willing to pay in this pursuit?

Portfolio costs come in two categories: fees (transaction costs or management fees) and taxes. Each of these eat into the returns a portfolio generates. That drag is intensified in times of low returns. Being wise about your cost budget means considering how low-cost exchange-traded funds (ETFs) might work together with high-conviction active strategies. In short: You want to consider where it makes sense to pay more for manager skill and high-conviction ideas vs. gaining broad market exposure with index-tracking investments.

For example, if an active manager has displayed an ability to outperform the benchmark by 1% over time, and you only pay 0.5% extra in fees and taxes in order to achieve that return, then that trade off might be worth making if you believe the manager can continue to deliver at that rate. If you can’t identify a manager offering this kind of benefit, then it may make more sense to opt for the broad market exposure at a low cost.

While these are three seemingly simple questions, they require hard thought to arrive at meaningful answers around which a productive investment portfolio can be built and oriented. Working with a Certified Financial Planner can bring objectivity and expertise to the conversation. It might also bring some peace of mind. Research shows that investors who work with a Certified Financial Planner feel more confident and better prepared for their financial future. Your life goals deserve that much. No questions asked.

Investing involves risks, including possible loss of your capital. The value of your investment can fall as well as rise and you may receive back less than your original investment.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any products or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. As such, no guarantee of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions is accepted. Reliance upon information in this post is at the sole discretion of the reader.

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