17 Nov Financial security — plan for it
When it comes to financial security, it is important to have a plan. As the old saying goes, failing to plan is like planning to fail. You should, in consultation with a professional financial planner, devise a written financial plan that takes the following factors into account
Your goals and objectives
Make sure your financial security goals are appropriate and achievable. For example, planning for your child’s tertiary education or planning to retire at 60 are goals and objectives whereas planning to beat the market is not an appropriate goal or objective.
You should, with the help of your financial planner, be able to define the risks to your portfolio. Risk tolerance is very personal and differs according to each individual. For a 30-year-old saving for retirement, short-term volatility should not be too important, whereas volatility will be crucially important to a person only months away from retirement.
Inflation must be taken into account as a significant risk for every investor because of its ability to erode the purchasing power of any capital.
This is the split of a portfolio among the various asset classes (bonds, property, cash and equities). Your asset allocation should help achieve your financial security goals while minimising risk.
A 30-year old saving for retirement should have most of his or her assets invested in equities, which outperforms inflation over time. A person who is only months away from retirement should have an asset allocation less weighted towards equities and property. However, this is not an absolute rule, the final decision must be dictated each individual’s requirements.
This ensures that all your eggs are not in one basket. Asset allocation is the first level of diversification. Within each asset allocation you can get further levels of diversification. For example, within equities you may diversify your portfolio by choosing large-cap, mid-cap or small-cap stocks or diversify by choosing equity managers with different investment philosophies.
Appropriate time horizon
Your written plan’s guidelines will help you adhere to a sound long-term policy even when market conditions are turbulent.
Having a well-researched investment plan and sticking to it is not as much fun as trying to time the markets, but it will more likely to contribute to long-term financial security.
Most investors are too focused on the short-term results. For example,if you are saving for your retirement in 30 years, what the stock market does this year or next year shouldn’t be your biggest concern. If you are saving for a child’s tertiary education and he or she is in primary school, your time horizon is shorter and this should be reflected in your asset allocation.
Rebalancing is the process of returning your portfolio to its target asset allocation as outlined in your financial plan. Rebalancing may be difficult when it forces you to sell an asset class that is possibly performing well and buy more of your poor performing asset classes.
A portfolio allowed to track the market returns ensures that certain asset classes will be overweight at market peaks and underweight at market lows. This is the same as buying high and selling low – a formula for poor performance and ultimately, no friend of financial security.
Investors select asset classes, strategies, managers and funds based on ‘past performance’. Chasing past performance has probably led to more bad investment decisions than any other single factor. A comprehensive study done in the US indicated that the dollar-weighted returns were consistently lower than the time-weighted returns.
Over the course of an 80-year period in the US, investors received 1.3% less a year because they went in and out of funds at the wrong time. At first impression this does not seem like much, but the compounded effect over a period of 80 years is mind-boggling. If a particular asset class, strategy or fund has done well for five years, we know only one thing with certainty — we should have invested five years ago. We should not necessarily be pouring money into the fund now.
Financial reporters purporting to know which is the next top performing share or fund often destroy more wealth than they create. In today’s world of instant communication and information at our fingertips, once the news of a hot stock has hit the press it has already been factored into the share price.
To remain objective and focused on your goal of future financial security, engage the services of an independent fee based CERTIFIED FINANCIAL PLANNER® professional to help you to develop your financial plan or review your existing financial plan.
Remember that your financial plan should be reviewed annually and sooner should there be any life-changing event, for example, a change of career, birth, death or divorce. If you do not have a CFP® professional visit the FPI’s website at www.fpi.co.za to select one.
Debbie Netto-Jonker CFP® is the founder of Netto Financial Services and was Financial Planner of the Year in 2001.