Guide to Investing | Pension Drawdown Company

The importance of investing: Plan for a bigger picture

This following information is based on J.P.Morgan Asset Management “Principles of Successful Long-term Investing” and used with their kind permission.

Principles for long term investing:

Markets and investments do not always increase they can go down, and have rough patches that may last a month, a year or more. But history suggests investors are much less likely to suffer losses over longer periods and therefore it is important to stay invested. Being invested matters, volatility is normal, Invest for the future!

The principles listed below are to provide guidance on understanding some of the key aspects of successful investing.

  1. UNDERSTAND YOUR ATTITUDE TO RISK: Know what it means

    The general principle of risk and reward is that, the greater the risk, the greater the potential reward. In terms of ‘investment risk’ it is important to note that risk means both fund volatility and the chance of losing all or part of your money. The more risk you expose your capital to, the more chance you have of losing part, or even, all of it.

    An investment portfolio typically consists of a mixture of assets in line with an investor’s attitude to risk.

    Investor portfolios with a lower appetite for risk:

    At The Pension Drawdown Company we rate these as 3 or 4 out of 10 and they will contain more defensive assets than growth assets compared to Balanced or Growth Investors. (Individuals categorised as 1 or 2 out of 10 typically don’t have the appetite for investing in asset-backed investments). Defensive assets include, Cash, Fixed Interest investments, such as Bonds, as well as Absolute Return Funds. The Growth proportion of defensive portfolios will hold more property and UK investments, as whilst they may not have the highest growth potential (compared to Asia for example), they provide an element of growth whilst exposing investors to lower levels of volatility.

    Investor portfolios with a higher appetite for risk:

    At The Pension Drawdown Company we rate a balanced strategy investor as 5 or 6 moving towards adventurous rated as a 7 8 9 and 10. These will contain an increasing proportion of growth assets as they move up the risk scale. Growth assets include Equities and Commercial Property. The type of Equities and the Geographic regions they are invested in will also vary according to the risk profile. For example, higher risk investors may hold more specialist equities (i.e. funds that invest in commodities) or have greater exposure to emerging markets such as Asia and India, which typically offer great growth potential albeit with high levels of volatility.

    The short of it is that Investors can’t expect growth or sustainable incomes from their portfolios if they aren’t willing to absorb any fluctuation in value or take any risk. All investments carry risk, but assessing how much fluctuation in fund value an investor is comfortable with and, more importantly, can afford (i.e. their capacity for loss), is at the heart of financial planning and essential in choosing the right mix of investments.

    For example, an investor in Pension Drawdown, who wants £1,000 per month income from their £300,000 portfolio, should seek advice from their adviser whether that is sustainable given their attitude to risk. The options are then to:

    1. Accept the volatility if you have sufficient capacity for loss
    2. Reduce the income expectation in line with what a suitable portfolio can sustain
    3. Accept that the capital value of the drawdown will be eroded and may not last your lifetime
  2. LIFE EXPECTANCY: You may live longer than you expect.

    Running out of money is a real retirement risk. It is a matter of fact that people are living longer. Public Health England have reported that life expectancy figures for England are the highest ever recorded for nearly all the areas covered in the study (65,75,85 and 95 years).


    Advances in medicine and healthier lifestyles mean people are living longer lives. The graph on the left shows the probability of reaching the age of 80 or 90 for someone who is 65 today.

    A 65-year-old couple might be surprised to learn that there is a 50% chance that at least one of them will live another 25 years, reaching the age of 90.

    If we live longer and don’t wish to work for longer, we need our pension to pay out for longer.

     

    Source: J.P.Morgan

  3. CASH INVESTMENTS : Cash isn’t necessarily the safe option

    Investment returns on cash.

    Investors often feel that holding cash is safe and often use it as a haven during volatile times or periods of media driven market speculation. Investors who use cash as a source of income, particularly during the ongoing era of ultra-low interest rates have been exposed to depressed returns on cash. In real terms when the impact of inflation over time is considered, cash savings have been vulnerable to erosion of real capital value.

    The erosion of real capital value is best understood as follows: A Chocolate bar may have cost 25p ten years ago; today the same chocolate bar may cost 50p. Therefore 25p today is not worth the same as it was ten years ago.

    Money sat under a mattress is losing its real value!

    The current environment means that the days of an 8% return on a Cash ISA are over. With interest rates expected to remain low, investors should be sure an allocation to cash does not undermine their long term investment objectives.


    Source: J.P.Morgan Asset Management - Guide to the Markets - UK

    Source: J.P.Morgan Asset Management - Guide to the Markets - UK

    The impact of cash over the long term:

    Investors who have been safeguarding cash in the long term may unexpectedly have achieved the opposite to what they were expecting.

    In addition to the erosion of its real value against inflation, Cash earns very little in the long run. The chart above on the right illustrates the growth that investors would have missed out on had they parked their cash in the bank.

  4. THE POWER OF COMPOUNDING: Start early and reinvest your returns

    Invest early and on a regular basis:

    The power of compounding should not be underestimated, it really shows how you can put your money to work and watch it grow. When you earn interest on savings, that interest earns interest on itself and this amount is compounded regularly.

    Even missing out on a few years of saving and growth can make an enormous difference to an investor’s eventual returns.

    According to research carried out by JP Morgan, starting to save at the age of 25 and investing £5,000 per year in an investment that grows at 5% a year would leave you with nearly £300,000 more by the age of 65 than if you started at 35, even though overall you would only have invested an extra £50,000.

  5. VOLATILITY IS NORMAL: Accept it as part of investing

    Avoid emotional biases during market downturns and stick to a plan

    It is human nature to feel nervous when watching the value of a fund go up and down but it is important to remember that this is a normal part of being invested.

    As already highlighted, the amount of volatility an investor experiences is related to the amount of risk an investor is prepared to take to meet their investment objectives. Risk and investment reward is a balance that relates directly to the volatility a portfolio experiences, it is therefore important that investors are correctly invested in line with their attitude to risk. This balance also relates to the amount an investor can afford to lose and the volatility they can tolerate without jumping to sell an investment for fear of loss before it has chance to recover.

    Generally speaking you can’t have reward without risk and this is the balance that your advisor will talk to you about to so you are comfortable with the market downturns, rather than reacting emotionally as previously described when the going gets tough. Don’t forget, more often than not a market downturn is an opportunity to buy, not a reason to sell.


    It is important to remember that every year has its rough patches. The graph above produced by JP Morgan uses the FTSE All-share index to represent the maximum intra-year equity decline in every calendar year. This illustrates the difference between the highest and lowest points reached by the market in those 12 months and the recovery. It is hard to predict these pullbacks, but double-digit declines in markets are a fact of life in most years; investors should expect them.

    To avoid our worst human tendencies, investors should work with a qualified investment advisor and adhere to a disciplined plan.

    Source: Principles of Successful Long-term Investing – UK 2017, J.P.Morgan Asset Management. Returns are based on local price only and do not include dividends. Intra-year decline refers to the largest market fall from peak to trough within a short time period during the calendar year. Returns shown are calendar years from 1968 to 2016. Data as of 31 December 2016.

     

  6. THE IMPORTANT OF DIVERSIFICATION: Don’t put all your eggs in one basket

    Markets can be volatile and the future is unknown.

    Investors are exposed to the yearly tapestry of natural disasters, geopolitical conflicts and speculation over financial crises. Diversification is a key part of smoothing the ride and during the last 15 years, cash has been one of the worst performing asset classes.

    Don’t put all your eggs in one basket. Despite the difficulties, the worst-performing asset classes of those shown here have been cash and commodities. Meanwhile, a well-diversified portfolio, including stocks, bonds and some other asset classes, has returned above 8% per year over this time period. The diversified portfolio has also provided a much smoother ride for investors than investing in just equities, as shown by its position in the chart’s volatility column.

    Asset class returns (GBP)
    EME: Emerging Market Equities
    Cmdty: Commodities
    Hedge Funds: Hedge Funds
    Portfolio: A mixture of assests
    Govt Bonds: Government Bonds
    DM Equities: Developed Market Equities
    Cash: Cash
    IG Bonds: Investment Grade Bonds
    EMD: Emerging Market Debt
    HY Bonds: High Yeild Bonds
    REITS: Retail Estate Investment Trust
    Source: Principles of Successful Long-term Investing – UK 2017, J.P. Morgan Asset Management. Annualised return covers the period from 2007 to 2016. Vol. is the standard deviation of annual returns. Govt bonds: Barclays Global Aggregate Government Treasuries; HY bonds: Barclays Global High Yield; EMD: JP Morgan EMBI+; IG bonds: Barclays Global Aggregate – Corporates; Cmdty: Bloomberg UBS Commodity; REITS: FTSE NAREIT All REITS; DM Equities: MSCI World; EME: MSCI EM; Hedge funds: Credit Suisse/Tremont Hedge Fund; Cash: JP Morgan Cash United Kingdom (3M). Hypothetical portfolio (for illustrative purposes only and should not be taken as a recommendation): 30% DM equities; 10% EM equities; 15% IG bonds; 12.5% government bonds; 7.5% HY bonds; 5% EMD; 5% commodities; 5% cash; 5% REITS and 5% hedge funds. Returns are unhedged, total return, in GBP. Data as of 31 December 2016.

    Key takeaway: Being invested matters, volatility is normal, invest for the future!

    Generally speaking you can’t have reward without risk and this is the balance that your adviser will talk to you about to so you are comfortable with the market downturns, rather than reacting emotionally as previously described when the going gets tough. Don’t forget, more often than not a market downturn is an opportunity to buy, not a reason to sell.

    It is important to remember that every year has its rough patches. The graph above produced by JP Morgan uses the FTSE All-share index to represent the maximum intra-year equity decline in every calendar year. This illustrates the difference between the highest and lowest points reached by the market in those 12 months and the recovery. It is hard to predict these pullbacks, but double-digit declines in markets are a fact of life in most years; investors should expect them.

    To avoid our worst human tendencies, investors should work with a qualified investment advisor and adhere to a disciplined plan.

    Supporting Sources:
    FE Analytics
    J.P.Morgan Asset Management “Principles of Successful Long-term Investing” 2017

Risk Warning exclamation mark icon

The Importance of Investing Guide provides comprehensive data and commentary on global markets without reference to products. It is designed as a tool to help clients understand the markets and support investment decision-making in collaboration with their Financial Advisor. The guide explores the implications of current economic data and changing market conditions.

The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from The Pension Drawdown Company and any providers referenced to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice.

All information presented herein is considered to be accurate at the time of writing. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products.

Risk Warning exclamation mark icon

The Importance of Investing Guide provides comprehensive data and commentary on global markets without reference to products. It is designed as a tool to help clients understand the markets and support investment decision-making in collaboration with their Financial Advisor. The guide explores the implications of current economic data and changing market conditions.

The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from The Pension Drawdown Company and any providers referenced to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice.

All information presented herein is considered to be accurate at the time of writing. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products.