Spike Milligan once said – “Money can’t buy you happiness but it does bring you a more pleasant form of misery”.
Consciously or otherwise, many investors have the above statement in mind when deciding to invest their hard earned savings. However, the returns one needs or wants to make from the invested capital normally reflects the stage in life the person is in.
There are a number of questions which need to be addressed when designing an investment portfolio for an individual: i) the investment time horizon, ii) the investor’s tax status, iii) any future liquidity needs the investor foresees at the outset, iv) any unique circumstances the investor needs to have addressed, and v) any legal or regulatory characteristics (this last point is normally applicable to institutional investors). However, even more important is the achievement of a return the investor demands vis-à-vis his/her overall risk profile. This latter point will be the subject of another article. Today we shall be looking at return.
Return normally falls into one of two categories which could sometimes also be addressed simultaneously: that return which an investor needs versus that return which an investor wants. These two categories are normally very strongly linked to the stage in life the investor is currently in.
A young professional with a steady income stream would usually want to invest capital to try and achieve a desired (want) rate of return which normally reflects a want to grow his/her capital base. The underlying investments for such a portfolio would normally focus on capital growth rather than the generation of income, typically carry a higher risk profile and finally may require a medium to long term period of time to realise their returns.
On the other hand, a person reaching retirement age would demand a return required (need) to maintain the current lifestyle throughout retirement age. Such an investor would want to target assets in order to generate an income stream, which is paid annually (or more frequently) with the least possible amount of risk and volatility. The main differentiating characteristic between the young professional and the person about to retire is the element of human capital; the ability of generating an income stream through employment.
These two individuals would be at either extreme of the investor spectrum. Like the life cycle itself there are many different stages which investors come across that must also be addressed. One very common stage is when children are born. Shortly after the joy of becoming a parent, one typically starts thinking of the financial requirements so as to provide the best possible upbringing for their child over the years.
At this stage, the young professional who had an investment portfolio made up of capital growth stocks may wish to create another portfolio (within the existing portfolio or along side it) in order to help pay future college or possibly university fees. This second portfolio will typically carry a more conservative risk profile to the first since the parents will be less tolerant to volatility. This is mainly due to the fact that, uncertainty related to investments which are required to finance long term commitments (such as school fees) is not the objective of this portfolio!
On the other hand, the time horizon is another important factor. The longer the time horizon (if planning for university fees) the more patient the investor is and therefore the portfolio would likely be more aggressive, whilst if the time scale is very short (if planning for primary school fees) than investor patience is much less.
As can be seen, one of the main determining factors for any investment portfolio is the age of the investor. The younger the prospective investor is the less financial commitments he/she has, which would be reflected in the nature of the underlying investments. On the other hand, an older investor would have a different set of priorities for his/her investment portfolio. However, there are situations which influence the structure of investment portfolios which may not be related to age.
For example, an investor may receive an unexpected sum of money through some inheritance which may completely alter his investment portfolio. Naturally this would depend on the size of the inheritance, however, if this is considerable, an investor may be presented with a number of opportunities: i) the investor may wish to improve his/her lifestyle, ii) the investor may want to start making regular financial contributions to one or more charitable organisations. Whatever the outcome of these decisions, it is very likely that the existing investment portfolio would have to be altered in order to cater for decisions resulting from an unexpected windfall.
Therefore it is very important that one analyse s his/her stage in life and personal circumstances before proceeding with any investment. It is irrelevant to look at how individuals around you are investing precisely because the likelihood of being in exactly the same boat is extremely remote.
This article has been prepared by Karl Micallef, an investment executive at Curmi and Partners Ltd, and is the objective and independent opinion of the author. The information contained in the article is based on public information. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
www.curmiandpartners.com
Mr Micallef is an investment executive at Curmi & Partners.