Question:
At age 24 I signed a five-year contract (maturing in November 2009) with Old Mutual for a medium risk fund comprised of mostly equities. The 'advisor' assured me this was a good fund; I'm young after all and compound interest…blah, blah, blah... I've contributed R60 000 to date and my policy is worth R43 000!

Lesson learned, but was my money better off in a money market account? Is investing in (fixed term) contracts limiting myself as a young investor? Should I be able to move money around quicker?

I'll appreciate any advice or websites you can recommend so that I can spot a lemon without having to waste another five freaking years!

Answer:
I can understand your frustration. Why is it that we so often get investment advice without being made aware of the potential consequences of our decisions?

In order to protect ourselves — and manage our own investment expectations — it is always useful to have a few guidelines to help us understand not only what the right solution is, but also to appreciate what we let ourselves in for when we make our decisions.

From your question, there are two issues that I would like to explore to help us consider such a framework. These are: how do I decide where my money should be invested and is a policy always the right way to go?

So let’s start with the first question. Most of us who have seen an investment adviser or an insurance agent have gone through the typical investment advice process. Basically, this consists of completing a risk analysis questionnaire which tells us that we’re conservative, moderate, aggressive or somewhere in between. This then leads to the asset allocation selection in our portfolio (cash, shares, property, international investments, etc.), which will in turn dictate the kind of return we can expect. Finally, the return will determine if we will have enough money to reach our financial objectives. These include anything from retirement to buying a home or educating your kids.

More modern thinking in investment advice has started to argue that this process is actually the wrong way around. For investment advice to be relevant, it has to start with an understanding of what you want your money to achieve. Once this has been done, your financial planner can help you understand what kind of return your money will need to generate in order to ensure that your objectives are achieved. This should dictate the asset allocation of your investment, which will in turn lead to the level of risk that you need to be exposed to. Your financial planner should help you understand what exactly this risk (or chance of losing money) entails and how it will be managed over your investment time horizon. If you are not comfortable with the level of risk you need to assume, you should go back and revise your objectives until you are left with a solution that will allow you to sleep at night.

If we apply the above as a framework for choosing our investment portfolios, it becomes clear why something like a money market investment is not always the right answer. If we take tax into account, many investors are left in a position where their money market funds’ returns are less than inflation which effectively means that they’re going backwards. By combining different asset classes, you allow yourself to get exposure to other areas that can provide you with growth in excess of inflation. What is important to note, though, is that combining these asset classes in a way that takes your risk tolerance into account allows you to manage the likely ups and downs that your investment portfolio will encounter.

This also brings me to a very important truth: investment returns should never be the sole basis on which your investment decisions are made. The level of risk at which those returns were achieved, the philosophy, people and process behind managing the strategy and cost as well as tax considerations are equally important. The problem is that most websites, publications and 'investment advisers' tend to focus on performance alone. This is backward-looking and is almost never a good indication of what to expect going forward.

As you’ve probably seen by now, doing this exercise properly requires a level of expertise that most financial planners may not have. The lesson that we as investors need to learn is that, before we make any investment decision, our financial planner needs to tell us exactly how they go about constructing and managing an investment portfolio in line with our needs. Some financial planners deal with this by outsourcing this responsibility to an asset consultant, which provides them with access to a team of qualified professionals who focus on achieving your investment objectives. Others choose flexible, managed collective investments which actively focus on moving your investment between different asset classes as markets change. Either way, the control over the investment management process is given to someone who should have a better chance of achieving the returns you need within the parameters that you are comfortable with.

Lastly, we have the question of long-term investment vehicles such as policies or retirement annuities and the place they should have in our portfolios. The first thing we need to understand is that these vehicles are merely a 'box' inside of which our investment portfolio (as detailed above) resides, and that the 'policy' does not generate your investment performance. These vehicles certainly do have a role to play. In main, their value resides in the fact that they are often very tax efficient and help us to be more disciplined. But sometimes they’re not as beneficial — as is often the case with young investors going into endowment policies. They can also be rather expensive as the commissions and administration costs involved with these can be exorbitant. Before you opt for such a vehicle, ensure that your financial adviser explains exactly what the benefits (and commissions!) are in comparison to a unit trust or another more liquid vehicle.

I hope that the above has given you enough to consider when it comes to selecting your future investment strategies and advisers. Unfortunately, there are a good number of duds out there. By asking the right questions, we should hopefully be able to give ourselves the best possible chance of spotting them before it’s too late.

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals’ personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.

If you would like acsis to put you in touch with an independent financial planner, click here!

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