By David Lamb CFP™ MCSI
I have seen many investors with a portfolio that has no real relevance to their lifestyle and ambitions.
Often they have some lower risk investments in deposit accounts and then longer-term investments to provide the best returns they can get, or an income to supplement their pension.
But far more can be done to make your money support your lifestyle.
In a previous blog I discussed having an emergency fund and then investing money in lower risk deposit accounts, to fund expenditure more than income within the short to medium term (up to five years).
Longer term, inflation is probably the biggest threat to your wealth.
I have said that I see an awful lot of people taking more risk than they need to take with their investments, but almost as common as taking too much risk is taking too little risk.
People fear investing money in the stock market so they keep all their hard-earned wealth in deposit accounts, safe in the knowledge that this time next year they will have the same amount plus interest. Unfortunately, they forget about inflation.
If you have £1,000 in the bank this year and earn 1% interest, next year you will have £1,010. Unfortunately, if inflation is 3%, the buying power of that £1,010 is only £979.
Their money is actually decreasing in value but the investor does not see that; however they do see the cost of living increasing.
To counter inflation risk, over the longer term you may need to take a little more market risk, but over the longer term history shows you will maintain the real value of your money.
If you are never going to run out of money, don’t take unnecessary risks to get more money than you need; it may go the other way. Instead, reduce your level of risk to just enough to match – or slightly beat – inflation.
Another consideration when structuring your wealth should be asset allocation and cost.
This often has the benefit of enabling you to ignore the financial industry’s hype. It is an industry full of people making promises they can’t keep, promises about ‘beating the markets, picking the best stocks and promises of high returns. If it sounds too good to be true, it probably is.
Thorough research shows that asset allocation and low charges have much more influence on returns than a fund manager’s skill (which can add more risk), market timing and all the other things the ‘industry’ claims it is good at.
If you would like to know more about evidence-based investing, we have an interesting booklet that we would be happy to email, free of charge. Please email firstname.lastname@example.org to request a copy.
It is also important to consider how your income requirements change throughout your life.
For example, in retirement you will probably want to spend more in the earlier stages (‘active’ retirement) than the later stages (‘traditional’ retirement) but many people are advised to take a level income throughout retirement. This often means they don’t have enough money when they want to spend it and too much money when they can’t spend it!
Again, cash flow modelling can help with this.
The main purpose of wealth is to support our lifestyles. As our lifestyle changes, our wealth needs to be able to adapt to those changes. If you do not know how much is enough, you do not have a financial plan.