We are all being asked to take a more active role in our long term financial well being. But doing so requires skill, knowledge and planning. Before delving into the issue of diversification, first, it is worth assessing the actual long-term risks that we need to prepare for and plan against if we are to develop an investment strategy that is likely to generate the best outcome for our money:
- Narrow spread of investment risk: This is a major feature for many people as was highlighted in the examples of so many people who had invested a significant proportion of their personal wealth in property or in bank shares, which were heavily linked to the health of the property market, when the value of both collapsed, so the personal wealth of a lot of investors. But these lessons should have already been learned. Before the property and bank collapses, there was Eircom where many people also lost a great deal of personal wealth and which should have served as a valuable lesson, but seems to have been either missed, ignored or forgotten
- Living longer risk. Many people are now living longer these days thanks to advances in medical care and new drugs, as well as important changes in lifestyle. However, the down-side is more and more people are at risk of living beyond ages for which their investment strategies may cater for. When it comes to a well thought out investment strategy, one must factor in how many years their investments will be needed for when they no longer have a regular income.
- Inflation risk is greater now than at any point since the Euro came into existence. The European Central Bank can and may use inflation to whittle away some of the overwhelming sovereign debt that continues to dog so many countries that share the common currency. If this happens, it will have a negative impact on any investment strategy, especially those that generate low levels of return. In recent years, the cost of purchasing utilities (fuel, electricity) have been on the increase and have been resulting in less and less disposable income for many retirees that depend on a fixed income in order to survive. Also, more recently, a significant prolonged drought across much of the US has resulted in a significant fall in food crop yields. Bad weather has also had a significant negative impact on food production across much of the EU and wider European region. As a result of US and European food production challenges, the cost of food is expected to rise. And in the long term, rising global populations are expected to continue to place significant upward pressure on most commodity prices, making that loaf of bread or gallon of fuel more and more expensive.
- Unexpected health care risk is another form of risk that we must all plan against. Ensuring against the probability of long-term health problems can sometimes be achieved by simple lifestyle changes. Genetic problems are a different matter. However, all health problems pose a significant threat to the long-term viability of even the best investment plans.
Diversification is relatively simple in concept but it requires constant attention monthly, weekly and perhaps even daily intervention to the makeup and structure of a personal investment pot to minimise risk as much as possible.
A well diversified investment plan will spread your money across a variety of risk categories. For example, while cash is often deemed to be among the lowest risk grades, it is susceptible to inflation. Putting all of your cash in a low interest bearing bank account may not be the best option if Governments internationally introduce monetary policy that cause inflation to rise. Equally, as referenced earlier, record poor weather in the US and EU has resulted in a record low harvest for corn and other crops which are expected to cause food prices to rise significantly. This will reduce the value of even the best investment strategies so it is really important that proper planning is put in place to protect any investment against the scourge of inflation. That said, cash continues to be a standard conservative risk category that will continue to serve a useful purpose for some time to come, but it should be one of a well balanced investment strategy.
At the other end of risk scale are equities (company stock). Investing all of one’s money into on company carry enormous risk that any fund manager would advise against. Investing into company shares has a useful purpose but it should be done sparingly and with a high expectation of loss. But since all companies are not the same, investing into different companies and across different industry sectors will help disperse the risk.
It is also highly recommended that any investment diversification factor in the age of the client for added measure. The conventional rule of thumb calls for a lowering of risk as one gets older. In other words, take more risks when you are young, if you lose on an investment, you have time to recover. Take fewer risks with your investments as you age as you will have less time to recover before you need your money the most.
Finally, I cannot make this point enough. There is no substitute for proper independent advice and the public should not be afraid to pay someone to provide them with good advice as to their options.
A well diversified investment portfolio should carry varying degrees of high and low risk investments that cater to the long-term lifestyle needs and goals of the customer. Age is an important determinant of the levels of risk and it is really important that the investor understands the links between their own personal goals, the propensity of loss, the types of risk and what their long-term (as well as short-term) goals are. Holding cash may seem wise but if it is the only investment strategy, then it is likely to prove a flawed one in the long term. Long term planning is perhaps the best investment diversification plan. Finally, don’t be afraid to pay or advice. It could be the best investment you make.