A well structured financial portfolio can increase the returns on your money, while allowing you to manage the risk.
The picture of what you own, both assets and liabilities, is your PORTFOLIO.
Asset Allocation
Remember from previous discussions your Asset Allocation, within your portfolio, is the proportion of your money invested in different asset classes.
The Assets you invest in will depend on the following:
- –What you need your money for.
- –When you need your money.
- -The amount of risk you are will to take given the assets volatility.
- -Your limitations and your opportunities given your circumstances. (country you live in etc)
Below we discuss how you best place your money.
We discuss your first investments,
through your wealth building phases,
until you finally need to manage substantial wealth.
Your First Investments
–Cash for emergencies
–Medical Insurance
–Life Insurance
–Savings: a Beginning
-Starting to Save Early
–Regular Savings
–Lumps of Money
Managing Larger Sums
Minimising Risk while investing for the long term
Your First Investments: –
In the beginning you start with little.
As time passes you hope to end up with a lot.
When you start your first job you will have enough for food, a decent set of clothes for the office, transport and a little money for fun.
Your greatest asset is your capacity to get things done.
Cash for Emergencies
Things do go wrong. You want money for these situations.
‘Cash is King’ in an emergency such as a car accident, loss of job etc.
3 month’s salary in an interest earning savings account can save you a lot of problems in an emergency.
Example of a savings buffer:
Jim is married and has one baby child with his lovely wife, June.
There is trouble at the company where he works..
On a Monday morning he hears that he has been laid off.
He will get 3 months salary and then nothing.
Even though things have been tight he has built up a three month emergency fund.
This will give him at least 6 months to look for another job.
Medical Insurance:
At a young age you are less likely to fall ill. Insurance premiums are lower.
However, accidents can happen at any time.
Medical insurance will give you the option for life saving surgery. It will help ensure you are not left with a huge medical bill.
Separate insurance can be bought that covers accidents only. It is better to have both illness and accident medical cover, but, if you can only afford Accident cover, this is better than no cover at all.
Payment is usually monthly or annually.
Hunt around different insurance companies to get a picture of what medical problems are covered and at what cost.
Life insurance:
You are married to a nice man or lady. You may even have children?
What will their lives be like if, you, the main bread winner is killed in a car accident.
How will they feed themselves?
Who will pay for their schooling?
Life Insurance will pay out to ‘the Beneficiaries’ (your family) an agreed sum upon the ‘insured’s’ death.
The loss of a close relative is bad enough.
You want your family to have enough money to cover bills.
‘Term’ and ‘Whole of Life’ Insurance
Term Insurance is suitable for young people on a lower salary, as well as for people who don’t want to mix up their insurance with their investing.
The premium is for a chosen period, e.g. 10 years.
A 100% of the premium goes towards paying for the insurance.
At the end of your chosen period, e.g. 10 years, the insurance policy lapses.
The premium is lower than ‘Whole of life’ insurance.
Whole of Life Insurance: As you pay your premium, a portion of the premium goes towards Life cover (where a lump is paid to you upon your death), and a part goes towards a savings pot that is invested in the financial markets.
The premium (regular payment) is higher because of the savings element. Over time your savings pot grows.
There are variations to the structure of insurance policies.
You need to talk to Life Companies to find a product that suites your circumstances.
The important point of the insurance is that a lump of money is paid out to your family should you unfortunately die.
Savings: a Beginning
You now have Medical Insurance, Life insurance cover, and have a small emergency fund in your bank.
Your earnings increase as you climb another step up the career ladder.
As your monthly cash needs increase so you need a bigger buffer against a loss of income or a large expense.
An emergency buffer could be anything from 3 months when you are at the beginning of your career to more than 2 years worth of spending when you have built up liabilities, such as school fees, mortgage payments etc.
Some of the options for placing the emergency money:
- Cash/Bank Current account
- Bank Savings account which earns a little interest
- Money market funds and their equivalent
- Short term government Treasury Bills- 3month or 6 month.
Starting to save early
The sooner you start saving the larger will be the pot of money when you need it.
Remember a single 10,000/- invested over 40 years, giving a return of 10% each year, will be worth 452,000/- in 40 years.
Regular Savings
The time will come when you can put aside a little money each month. This money can be the first of your investments.
This money can be put into your savings account, or if larger into regular payment savings plan offered by financial institutions.
A regular savings plan requires continual saving per period (e.g. 10,000/- per month).
This contribution to the saving plan should continue over an agreed time frame.
An example:
Jim has a salary increase. He already pays for medical and life insurance as he has a wife and a daughter, Sally. At the beginning of the year Jim begins to receive a salary increase of 15,000/- after tax.
He is beginning to think of school fees. He also didn’t take a holiday the previous year because of the Corona Virus. He decides to put 5000/- a month towards a holiday into a savings bank account, and 10,000/- a month towards Sally’s education into a Savings Plan.
He looks at a number of regular savings plans with different financial institutions.
The plan he chooses will allow him to save for 10 years.
The savings plan rules dictate that he must keep saving his 10,000/- a month, or he will lose a lot of the money he has built up in the plan.
Though he doesn’t like the thought of losing a lot of money if he stops contributing to his Savings Plan, this thought will keep him a disciplined regular saver.
Sally is more likely to go to a good school if he keeps up the savings.
Very importantly, the charges on his plan are the lower of all the options.
Charges on regular savings plans can be very high.
He doesn’t want his savings to be eaten up by fees.
Lumps of money
Another option to a regular savings plan is to build up enough money in your bank saving’s account to invest into a lump sum plan. This will accept your lump sums when ever you wish to invest . Lump sum investments usually have lower fees.
Note: It is easy, however, to make a plan to save and then events take over and you end up not doing so. You spend the money on ‘stuff’ instead of saving.
You then lose the real benefit of compound interest over a long period of time.
Starting to regularly save at an early stage is important. It will make a big impact on the final lump of money you end up with.
Managing Larger Sums
Money needed within 7 Years
Long Term Investments- over 7+ years
A successful business or a successful career has left you with a good sized lump of money.
You want this money to work for you.
How and where you invest should be dependent upon what money you need and when you need it.
Your Emergency Money
Your first priority is to have enough money you can easily lay your hands on for emergencies.
See Note above, under ‘Cash for Emergencies‘.
Money needed within 7 Years
You have things you want to buy within the next 7 years, e.g. the start of school fees.
You will want your money when you need it.
You will want this investment to have grown a little.
You don’t want your investment to lose value just as you need the money.
You are looking for low volatile investments.
Riskier assets such as Equities, and property etc. have an increased risk of losing money just as you need the money, so are not suitable.
Investing in Local Debt:
- Bank savings accounts
- As long as the bank and the government stay solvent you will get your money back with the pre-stated interest.
- Money in bank accounts will give you a low return but is easy to get at.
- Short term (3 month to 1 year) Kenya government T Bills.
- A better return than banks, but less liquid and more cumbersome.
- A better return than banks, but less liquid and more cumbersome.
With a larger sum of money you can look at international investment options.
International Mutual Funds(Bonds) – Triple A rated short term government bonds
Fixed interest mutual funds that focus on Triple A rated Government debt with a low duration.
- The bonds have a low risk of insolvency.
- The money is spread between a number of high rated, low duration Government Bonds (e.g. Short term US Treasury Bills.)
The low duration (short period to maturity) means a relatively smaller loss in value of the capital if interest rates rise.
These have low risk but low return.
Note:There is a currency risk. If your home currency increases in value in relation to international currencies you will suffer a currency loss. If your home currency decreases in value you gain on translating and visa versa.
International Mutual funds- High Yield Bonds.
High Yield Bonds, include a mix of corporate debt and higher risk, emerging country, government debt.
- The value is more volatile and the risk of loss higher, but with a higher expected return than the Triple A short term Government Bonds.
- However, we would expect less volatility but with lower returns than is the case with equities.
- There is also the same currency risk.
Explanation:
If interest rates increase (decrease), bond values fall (rise).
Duration is the sensitivity of the value of the bond to interest rate changes.
The longer the duration (the longer the term of the bond) the more the value of the bond changes with the country’s interest rate changes.
e.g. With an interest rate increase there is a tendency for a larger fall in the capital value of your investment. i.e. the price of each bond.
So, on a spectrum of risk- the lowest risk to your investment losing money will be a low duration (short period to maturity) bond that is Triple A rated debt.
However, with low risk you can expect a low return.
How do you decide how to divide your money between your local bank, Kenya T Bills, Ultra safe overseas bonds, and local and international High Yield Bonds?
Your appetite for risk:
If you don’t like risk you will be comfortable in bank accounts and short duration, sovereign T Bills.
If you can accept higher risk you will have a higher proportion of your money in High Yield debt where there is higher volatility and risk of loss, but potentially a higher return.
(Compared with equity investments, High yield debt tends to be lower return and lower risk).
The importance of your purchase:
You may feel you can take greater risk with the money for a holiday home than you can for life changing purchases such as your children’s education.
The volatility of the environment at the time:
Are all the economies growing steadily or is there, for example, a pandemic induced financial crisis. The more volatile the environment the less risk you want to take.
To summarise- your choice of investments for 7years or less:
- If you need the money soon, to be invested with very little risk, invest in cash and short dated sovereign bonds in your home country currency.
- During pandemics, trade wars, social and political tension, be more conservative.
- For a better return and medium risk- invest in a mix of all options.
- For high risk and longer short term investment- a mix of all options with a greater proportion in High Yield Bonds.
- You might invest a small proportion of your money in mutual funds that invest in very large, stable companies if you accept higher risk and have more years before cashing in.
Long Term Investments- over 7+ years
The amount of money you have to invest is often large and is for important purchases such as school fees and retirement.
Often school fees and retirement cost more than we can ever save.
So, we accept a level of risk and invest in various assets in the hope of growing our savings.
Long term investments have a longer time to potentially recover from a down turn in value. For the long term we can thus invest in more volatile investments that have higher risk.
Minimising Risk while investing for the long term
What matters in assessing risk?
- The environment we are investing in.
The country with a strong legal system lowers the risk to your investments.
Financial regulations built to protect the investor minimises the chances of theft of your money and abuse.
- A financial institution with a reputation for sound management and that considers the welfare of their investors as a high priority, is a lower risk than one that doesn’t.
- The choice of professional manager.
–The management company should have a reputation for doing well for investors.
–The remuneration (pay packet) of your wealth managers within the company should be aligned with you, the investor. For example a part of her pay packet depends upon the long term performance of your money under her management.
–There is a low turnover of wealth managers.
–The wealth managers have a good track record for growing money.
-Their fees are reasonable
How do you get this information?:
Independent financial analyst companies make their money by assessing companies, and mutual funds.
Morningstar is one highly rated company. (Morningstar.co.uk)
Should all our Eggs be invested in one basket?
If you want to make lots of money you might focus your investment and time on one thing (e.g. your business start-up).
If you want to protect your money you diversify your assets and invest in a number of different things.
Diversification:
Putting your eggs into more than one basket reduces the chance of losing all your money because you have invested in one thing only.
There is a chance that a bank will go bankrupt. There is a chance that a share price will fall and not rise again.
If you have invested in different companies, different bonds and other types of assets, and one of these investments gets into trouble you will lose some money. If you have put 100% of your money into only one asset and this gets into trouble you could lose ALL your money.
Correlation: In addition, if your assets are not correlated, or actually move in the opposite direction, the ups and downs (volatility) of the value of your portfolio over time is smoothed.
Your portfolio as a whole will have the same return but with a lower volatility.
Assets that are Good for Diversification:
Collective investments e.g. Mutual Funds that holds many asset types- equities, bonds, property, commodities etc is a great way to add to the diversification of your assets.
Choosing the mix of assets into which we want to invest our money requires an expertise most of us do not have. A good Mixed asset fund allows us to buy this off the shelf.
Information on Mutual Funds (Collective Investments):
Third party analysts such as Morningstar.co.uk, through their WEB site, describe the funds and for many of the best funds give them a rating of expected future performance.
Morningstar.co.uk and Morningstar.com
In summary:
- A good long term investment will rise and fall in value (be volatile) but has a probability of increasing in value over a period.
- Decide how much of a fall in value you can accept, then chose your investment accordingly.Panicking and selling when your investments fall in value could lose you a lot of money.
- Diversification into non correlating assets can reduce your risk for the same level of return.
- Diversification will reduce the chance or a catastrophic loss in value of your portfolio.
- The reward of investing in good long term investments is that, though volatile, you will have an acceptable probability that you will end up with more money than if you had left the money in the bank.
- Leave your money in a bank account for a long period and you are highly likely to be able to buy less at the end of the period than when you first invested. The reason is inflation.
Example Portfolios to help you Invest
Important: This information on this WEB site ALONE should not be used to make investment decisions. Investing is particularly personal and is dependent upon your circumstances. You are strongly advised to take independent expert advice before deciding whether to/ or whether not to invest your money.