We are reviewing the advice given in relation to investment risk:
We described your risk as 4 out of ten and you should therefore invest into a range of funds to achieve a return of 6% over the medium term.
Our advice on the above:
4 out of ten? What on earth does that mean? It’s like painting with numbers, as opposed to investing with science. Risk is about identifying what return you desire and ascertaining what fluctuation you are comfortable with in pursuit of that gain.
Investing money is about understanding what you are doing and in turn accepting what comes with that. Investment carries risk and the more risk you take the more the potential reward or loss – simple really. Loss is often referred to as total loss but its better described as a fluctuation in your capital i.e. one day its worth one amount and the next day lower or higher. It is rare that your capital will and should ever be placed anywhere that really puts it at risk of total loss. Prices in the stock market fluctuate and that, believe me, is very good. It is precisely that fluctuation which creates the opportunity to make money. Whilst some may buy their new TV on Xmas eve, others may buy in January in the sales and sell on again before the world cup. There is an aptitude to fluctuation that you will feel comfortable with depending on how you understand your investment.
Let’s first look at why you might want to invest at all. Last week I did a phone-in giving advice to a lottery winner on the radio. A question was asked: ‘How much would a million make me per week?’ I asked what the lottery winner (who had won £3.9 million) did for a living and what her earnings were. I then broke the news to her of her potential income. She had spent some money on capital outlay (most noticeably breast implants for her two sisters). She asked what she could invest into apart from the up front assets she had bought. She had noticed ING was paying 4.5% per year and proudly announced that this would bring in a cool £14,625 per month. Happy days we all might think.
Aaaah, but first the matter of tax. The income will straddle one tax bracket slightly but for the purpose of simplicity we will say that the whole income is taxed at 40%. This would bring the net income down to 2.7%.
Problem number two – inflation. If her capital does not increase in line with inflation it will lose value year on year. Inflation currently runs at 2.4% and is rapidly rising. (I wouldnt be surpised to see it leap through the government upper target of 3%).This will mean her net income is 0.3% or in real terms £975 per month or £225 per week – less than she actually earns now. Amazingly every week she still buys that £10 ticket! We can see from this that we have to navigate two issues: inflation and tax. Tax can be mitigated by choosing an efficient investment vehicle such as an isa, unit trust or offshore bond. Inflation can only be taken care of by introducing your capital to the potential for extra returns, which of course includes risk.
If you are not comfortable with that, you will simply have to accept an extremely low income or that your capital will fall in value. Don’t necessarily fret about risk as I mentioned above, as it’s by using that adversity that a fund manager makes you money.
Consider also that inflation is low at the moment. In periods of high inflation your capital can be eroded considerably. In order to obtain the best returns and minimise the risk, use a qualified investment IFA who really explains risk to you so that you know what potential fluctuation to expect followed by what potential upside. If you know that, there will be no surprises, either up or down. Do not get drawn into contrived arguments about being pro Asia or Technology or the latest lemming widget – it will only cost you money. Few advisers are appropriately trained to understand any sort of macro-economics. Instead, stay with a well balanced portfolio spread between a range of different funds and managers and you won’t go too far wrong.
Worldwide’s score: 3 out 10
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