Behavioural finance has an increasingly central part in conversations about investment risk, since managing emotional responses plays a key role in maximising returns.
Becoming an investor means making your money work as hard as it possibly can and it’s never too early – or late to start an investment portfolio explains Wendy Spires.
Put simply, investing is the process of putting money you already have to work in a bid to make more – committing capital to a specific financial activity in exchange for the promise of attractive financial returns. Common methods include lending it to a government or corporate in exchange for a coupon (fixed income/bonds) or through purchasing shares in company in the hope of gains and possibly also dividends being paid out (equities).
When viewed rationally, few would question the attractiveness of this use of capital. An individual’s assets often earn money at a much faster rate than they themselves can through employment, and that’s without the powerful effect of compounding. Furthermore, the sophisticated risk management and investment suitability processes the professionals are able to leverage mean that devising investment portfolios is very much a science as well as an art today. Yet there are still great swathes of potential investors sitting on the sidelines: it is estimated that only around 12 million people in the UK own shares out of a population of 65 million, for example.
The vast majority of people save diligently. The traditional wisdom is that everyone should have at least six months living expenses in reserve, but beyond that people may want to have a number of different “pots” for different financial objectives. Placing cash on deposit with a bank will garner some sort of return, although in recent years interest rates have been rock-bottom. However, as individuals build up more substantial sums they are likely to want to seek greater returns than a simple bank or building society savings account can offer.
The reason why people like cash products like savings accounts is of course the perception of safety – which is largely warranted. The Financial Services Compensation Scheme guarantees deposits of up to £85,000 that are placed with FCA-regulated institutions and while the returns on cash can be very low, it is also a very low risk asset class (although recent history has reiterated the lesson that financial institutions can indeed collapse; furthermore, the FSCS only applies per institution, per client).
Yet while people are right to think about preserving their wealth, they must also pay heed to the need to build on it too if they are to attain (and maintain) the financial security we all seek. Sometimes the safest option is not, in fact, as safe as it seems. A certain amount of caution is understandable, but industry experts are increasingly warning that some individuals are being self-defeating in that they are too risk averse and are not making their wealth work hard enough to fulfill their future needs.
Those with a very long investment time horizon – like those saving for retirement many years down the line – have a similarly long time to recover from any potential losses and so could well afford to take on more investment risk in a bid to generate superior returns. Indeed they may have to. The emphasis is increasingly towards individuals funding themselves in education, healthcare and retirement. The need for people to build up and successfully deploy several significant pots of money over a lifetime which may encompass several careers, businesses and even families has underscored the need for wise investment counsel at various stages of life.
One hugely important factor that is easy for reluctant investors to forget is inflation. Inflation erodes the spending power of capital over time and so money which is not invested in such a way that it at least keeps pace with inflation could end up being worth significantly less in real terms when it is required.
What’s more, when asset classes like property are rising very much faster than inflation this issue becomes even more acute. Therefore, keeping significant sums which aren’t likely to be needed at short notice in low-yielding cash deposit products may not be the wisest strategy. Wealth managers are able to devise investment plans suitable for every level of risk appetite and can cater to even the most conservative of investors.
Another key argument for investing is what Einstein called the “eighth wonder of the world”: compounding. This means that by reinvesting gains made from an investment portfolio returns are effectively magnified over time (and because the investment returns typically targeted by a wealth manager are generally much higher than cash rates this effect is very much more pronounced). This turbo-charging takes effect to the extent to which someone who invests in a pension for 30 years can end up with double the amount of someone who saves the same amount for twenty. Although it is best to start investing as early as possible to give compounding the maximum time to work its magic, it is never too late to harness its power to help build your wealth further.
Through carefully investing your wealth with the guidance of a professional adviser you will be able to build up a portfolio designed to provide precisely the right mix of income and capital growth for your needs, and with a risk profile which is appropriate to your circumstances as a whole. You may be surprised to discover what a professional investment strategy can help you achieve and whether you have very substantial or fairly modest sums to deploy there is sure to be an institution on the findWEALTHMANAGER.com panel that can help. Simply try our smart online tool.
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