Goals based investing; simple portfolio structures and rebalancing

How should risk-averse investors approach stock-market investment? Recent research gives some useful tips. My article in the Herald looks at some advice.

Clear thinking is needed at the outset about what an investment is trying to achieve. Trading too much and reducing stock market exposure at the wrong time can materially damage long-term returns.

Investors should think about structuring their investment to match their goals, recognising their own timeframe and potential for anxiety.

But reviewing this with quarterly time periods and standard benchmarks may be little help. Even Warren Buffett recently admitted his fund could be behind the S&P 500 Index over a five-year period – the first time since the 1960s. Investors would be wise not to pay much attention to that statistic; most have time horizons well beyond five years, and the index is not the measure of whether Buffett’s fund is meeting longer-term goals.

Much of what investors are told about performance and benchmarks is unhelpful. Indices reflect a one-size-fits-all approach that may be little guide to individual goals. And every investor has a different level of confidence and risk tolerance.

The potential for big rewards in years ahead may matter little if getting there is a white-knuckle ride. If a portfolio is not structured to take the rough with the smooth, investors can end up with losses, selling at just the wrong time.

Investors must be candid about their temperament, and match it with the right investment structure. Financial advisers recognise the need to probe individual psychology thoroughly before constructing a portfolio.

Maintaining a mix between shares and bonds has also proven its worth over the past decade. US research shows a fund with 60% in US shares and 40% in government debt would have beaten most hedge funds and university endowments. This simple approach would also have cost less, and would have proved relatively resilient in 2008.

In the UK, a number of charities and endowments have taken a similar approach, aiming for a balance that will help to smooth out stock market cycles. If an entire portfolio is invested in shares, there is little potential for taking advantage of market sell-offs.

Research also points to one useful thing investors can do on a quarterly basis: it is worthwhile rebalancing assets between major categories. If a portfolio is split between shares, bonds and possibly other asset categories such as deposits, rebalancing can help long-term performance.

Studies also point to the impact of costs and transactions over the longer term. On average, most investors lose by trading too much. A portfolio that is structured to be resilient should be given time to do its job. In recent years, some of the best performing shares and funds have also been the most volatile.

That should not distract investors from keeping sight of the longer-term and ultimate goals. Where a fund is selected or manager appointed, it would be good to document the basis of selection; the expectations in terms of gains and volatility. And, even more importantly, investors should write down the reasons on which they might switch out. Very often emotion is involved in the decision to redeem a fund or sell an investment, and that means timing is wrong. Documenting expectations in advance can help to avoid this.

The lessons are that investors should start with their own goal in mind, and only use standard index benchmarks where they match this. For some, the investment journey may be measured in ethical or sustainability terms. Shares have both the potential for making investors feel good, and at other times creating anxiety. The whole portfolio should be structured to handle that, rather than simply trading

.Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. Data and content provided are for information, education, and non-commercial purposes only. The information presented in this article has been obtained from sources believed to be reliable, however, I make no representation as to their accuracy or completeness and accepts no liability for loss arising from the use of the material. Articles and information do not represent investment advice.

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