8th Aug '21 by Edmund Shing

16 comments 1956 reads

Market Musings 08/08/21:

Defining Investment Goals, and the value of patience

During the dog days of summer when financial markets tend to drift, we all have an opportunity to reflect on our personal longer-term principles and objectives. After all, we all have differing financial situations, requirements, potential tax liabilities, risk tolerances and investment horizons, which then should be taken into consideration with respect to our portfolio setups.

Defining Investment Goals

This sounds obvious, right? Use my existing pot of money to make more money…

The reality for anyone who has stopped to consider this subject for a few moments, is that it can be anything but obvious.

Investment Horizon: let’s start with the obvious - someone who starts investing young, has in principle a long investment horizon. But this is not necessarily true, if for instance, they are saving up a deposit to buy their first house or flat. They may in reality need to cash in part or all of their investments sooner rather than later, in actual fact.

Similarly, one might assume that an investor who is already retired will want a steady stream of income, and is averse to taking much risk of investing for the long-term. But again, this may not actually be true, if for instance, this retiree already has sufficient pension income from a state pension plus other private pensions or other investments such as buy-to-let property. In this case, they may in reality have a long-term investment horizon for at least part of their investment portfolio, as they may be intending to eventually pass this investment capital on to their beneficiaries.
Risk Tolerance: risk tolerance is partly a function of investment objectives and time horizon, but also of psychology. It is all very well telling a young investor that they should be able to invest for the long-term, and thus be able to take a high level of investment risk in their portfolio.

But in reality, this may be true objectively, but what if the young investor is simply not comfortable with the ups and downs of a risky portfolio? One’s risk tolerance should be matched to our personal ability to cope with volatility. Ultimately, sleeping well at night is key! One of the biggest mistakes that retail investors typically make is taking too much risk in their portfolios. This is something that is easy to do when stock…

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kevin101

8th Aug '21

thanks for this Edmund. I always look forward to your candid thoughts

Frontrunner72

Great stuff Edmund! Many thanks.

Silver Moon

This is a great write-up, thanks Edmund, I'll be passing this on to my nephews.

Quest

Chris Dillow argues in this week’s IC that market timing is a significant influence on returns. The article is titled “the bias against market timing”. Worth a read.

Michael Tee

Hi Edmund,

Really good article.

Agree with all your points. It is all about working out what investment strategy fits your personality best and everyone is different otherwise we would all hold the same stocks.

I also really like that you say you make mistakes. Anyone not making mistakes is staying within their comfort zone and not trying anything new. Most successful entrepreneurs also made mistakes and these mistakes helped them achieve their success. PIs are a type of entrepreneur as most people do not do their own investing. We are allowed to make mistakes as long as we learn from them.

Michael

timarr

The detail of the article is important - Dillow is explicitly not arguing that we can day trade our way to a fortune:

Short-term market timing is impossible. Whereas the dividend yield explains 60 per cent of the variance in five-yearly returns on the All-Share index it explains only 1.4 per cent of the variance in monthly returns. That’s not enough to base a strategy upon. In the short-term, cheap markets can get cheaper and expensive ones more expensive. It’s only in the longer-term than mispricings are corrected.

The article, as is nearly always the case with Dillow, is about rationally following the numbers rather than narratives. As he puts it "... we don’t need detailed stories about the future. In fact, they are a positive menace".

Momoko Miyamoto

Low cost diversified ETF's have thus far been an excellent lower risk way to benefit from rising stock markets but there is now increasing concentration and valuation risk. If one buys a global index tracker then one's portfolio gets a heavy weighting to US tech stocks which are currently on high valuations based on historic multiples. Also many active managers are raising their game in terms of lower management fees and retail investors can build their own portfolio cheaper than ever. There was a time when it was contrarian to be invested in ETFs but this is certainly not the case any longer.

gus 1065

To address the risk of tracker funds/ETF‘s becoming too overweighted in a small number of behemoth FAANG type stocks there have been a fair number of equal weighted trackers launched. A good example is the Invesco S&P 500 Equal Weight ETF which puts roughly a 0.25% allocation in each of the c.500 stocks in the Index.

https://www.invesco.com/us-res...

ETF originators, especially in the US, are pretty creative at building ETFs to cater for any market sector or investment objective that they feel there is a demand for.

Also, I strongly agree with Edmund‘s comments that the U.K. pension legislative regime isn’t fit for purpose. Virtually impossible to plan long term when the rules are arbitrarily changed with every budget. In an ideal world pension legislation would be based on a stable established framework set outside petty party politics that is only changed in extreme circumstances. I suspect it will become even more volatile as future governments try and balance the post-Covid financial books and look to raid pension savings as a soft target.

Gus.

Simon Rowan

plenty of food for thought again Edmund thanks. I took all my tax allowance profit plus a bit more in the first two financial weeks of this year, thinking if I have any real disasters I still have some profit to offset towards the end of the tax year . I also have quite a few aim stock that are coming up for the 2 year hold in a few months time to avoid IHT. Two problems with them: I've no idea if they actually qualify because its not clear which AIM stock qualify for IHT relief, and will they still be in AIM in five years time. It seems there are fewer companies trying to transfer from Aim to the main index these days. Timing clearly would help increase the performance of a portfolio. The desperado sort of opportunities generally come around once every ten years. The last one being March 2020. I was almost 100 percent cash then mainly because I got the election result completely wrong thinking we couldn't be stupid enough to give Boris a majority. Turned out to be a great mistake. So luck also plays a big part. As Patel used to say sitting on your hands is one of the hardest disciplines for an investor.

I'm not sure equal weight ETFs are the answer either, these would systematically sell the winners and buy the losers in the index.

Agree that the constantly shifting UK pensions goalposts are very frustrating. However the existing regime of higher rate tax relief exacerbates income/wealth inequality. It seems likely that flat rate 25% relief will be introduced in the near future which will also incentivise lower earners to save in a pension. George Osborne had made steps in this direction with the Lifetime ISA until Brexit sealed his fate. The lifetime allowance is a terrible policy, discriminatory in favour of defined benefit schemes and needs to be abolished or increased significantly (fingers crossed).

pka

Another excellent article Edmund!

ricardomontalban

9th Aug '21

Thanks so much for this Edmund and can I also say thanks for the 3 brilliant podcasts you did with Tamzin on introducing families to investing. They were really great.

Can I ask a potentially stupid question? I'm assuming the power of compounding only occurs with dividend paying shares (and that those dividends are reinvested)? i.e. if one predominantly invests in growth stocks/small companies which don't pay a dividend we are relying purely on growth over time and there will be no "compounding" aspect?

Assuming the growth stocks are generating positive cashflow this will be invested internally and thus generate the compounding for you!

dcon85

Great article Edmund, the points you mentioned, as well as my own risk profile / tolerance are things I think about a lot.

Something I might add to the mix is the concept I think of as "funds not easily replaced". You could have two people with the say £50k portfolio balance, similar age, goals(?) and time horizon (both have basic needs food/shelter met). One however may earn £50k a year and the other may have a very limited earning potential. I find this adds an extra dimension potentially as the higher earner has the ability to add funds to the account over the course of a year or two in the event of a 10-25% draw down but the other does not have this ability. It theoretically might lead to less risk raking with the funds not easily replaced account.

Good points about patience too, it is probably the one thing I need to develop most!

Kelvin Prescott

10th Aug '21

Ricardo, the power of compounding works at its best for companies that are a) achieving a good return on capital, and b) do not pay a dividend. The reason for this is that most company's shares are priced at higher than their book value (book value = the amount of capital that investors have provided to the company), but retained profits are reinvested at book value.

Terry Smith (of Fundsmith) has written about this extensively to explain why his investment funds don't offer dividends, so worth having a read of one of the Fundsmith annual reports where he goes into this in a bit of detail.

Tradeseek

Typical of a fund manger to favor “time in the market” as opposed to trying to “time the market” we would not want a mass exodus from ones fund during a downturn in the market would we?

Market Musings 08/08/21: Defining Investment Goals, and the Value of Patience

Market Musings 08/08/21:

Defining Investment Goals, and the value of patience

Defining Investment Goals

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Edmund Shing

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