Pick The Perfect Investment Strategy
People are talking about money. There’s exploding interest in gaining back control of their personal finances and reviewing investment strategies. People are also making big changes, some by choice, some by necessity.
Here’s the process I’m guiding people through in their desire to re-work their investment strategies.
Start with what you want your money to do
In the context of investing, the purpose of linking your goals to your investments is to minimize disappointment. You want to make sure your investment is very likely to behave in a way that is in line with what you need and want it to do.
Very simply, pick one of three goals:
Grow this pot of money to a certain size by a certain time.
Preserve this pot of money to minimize chance of loss.
Generate income from this pot of money straight away.
There will be a range of investment products within each of the three goal categories that fall on the high to low risk spectrum. Therefore, don’t focus on risk too much in this goal-setting step.
If you know you need to grow your pot of money in order to buy what you want or retire with a certain amount, then your goal is growth. If you don’t need more income and don’t need the pot of money to grow that much, then your goal is preservation.
Emphatically though, start with this simple commitment to what you want your money to do, which defines why you’re investing. By the way, it’s perfectly reasonable to want an element of all 3 goals.
Measuring your investment success as a function of whether you’ve met your goal can provide comfort no matter what the markets are doing.
Instead of spending time thinking you can find the most profitable investment with the best timing, this approach allows you to reflect on what you want to achieve and to align your investments with those goals.
Investing according to your goals will very likely help you get unstuck if you’ve been uncertain about how to proceed.
Your Task: the first step before you ask anyone for advice on WHAT to invest in, is to be clear in your mind about WHY you are investing.
Reflect on how much of a roller coaster you can take
Risk tolerance is notoriously tricky to articulate. But when risk is related to a goal, it becomes easier to identify things that would be intolerable.
Then it becomes a manageable task to think about which risks are more likely and which would have the bigger impact. And it becomes clear which investment strategies are not appropriate.
The three basic categories of goals carry with them distinct risks.
The growth goal carries with it the risk that you’ll ‘ride the roller coaster’ of the market. A big risk with growth investing is that there might not be any growth at all; in fact, there could be total loss. There is an associated risk that you’ll bail out of the market at the bottom of the roller coaster because you’re afraid the market will never recover. Another risk associated with growth investing is that the timing of the market roller coaster will not coincide with the timing of when you want to use your money.
The preservation goal carries with it the risk that your money will not keep up with inflation. This means your money will not buy you what it could when you invested.
The income goal carries with it the risk that the investment pays out too much as income and does not put enough money back into its own sustainability. In this case, the share price might decline because the company doesn’t invest enough in itself and its own growth.
Note that within the 3 basic categories of goals there is a range of aggressiveness or riskiness.
Within the growth goal category, some companies are well established and therefore lower risk while others are a bit of a gamble if their product or service is unproven.
Within the preservation goal category, there are investment products that range from higher to lower risk. For example, a risk would be the likelihood of a bond going into default.
Within the income goal category, there is a range of risks related to the sustainability of the amount the company is paying out as dividends versus balancing dividends and operations. This is called the payout ratio, by the way.
Your task: In plain language, articulate your desired degree of aggressiveness. Click here to read about a way to conceptualize your risk management. Reflect on the importance of the goal and the timing before you complete this task. Would it be devastating or just disappointing to not meet your goal by the desired deadline? Would it be acceptable, for example, to only pay part of the tuition, delay the trip, or make less income in a given month or year?
Pick your investment mix to match your goals
Before choosing your investment products, you’re going to settle on the right mix of products, which is called your target asset allocation.
One way to think about your asset allocation is the proportion that each of your goals represents.
Did you choose 100% growth? 50% growth and 50% income? Or some other combination?
It could be that you need a certain amount of income right now, so you need to allocate an amount of money to an asset class that will generate enough income according to the prevailing interest and dividend yields.
And at the same time, it could be that you a have a lump sum of money that is driving you crazy just sitting there earning next to no interest, but you’re scared to death of what’s going on in the world and like the idea of having a healthy emergency fund.
Your task: Assign a percentage allocation to each of your goals, such as what might be 75% income and 25% preservation in the above example.
Pick a Platform
There’s a spectrum of platforms, and within each there’s a spectrum of degree of your involvement.
You can change platforms easily, so you’re not locked-in to the decision you make at the beginning.
On one end of the spectrum is the most DIY option and that is an online discount brokerage. On the other end of the platform spectrum is an investment firm at which you work with an advisor. And in the middle of the platform spectrum is an online Robo-Advisor.
Online discount brokerage platforms are the cheapest option. You will pay a small commission per trade, often a flat fee regardless of the size of the trade. If you buy funds, you probably won’t pay a commission to buy or sell, but you will definitely pay the annual Management Expense Ratio (MER) fee (click here to read more about investment fees), as you would in any situation. You make all the decisions, although you have access to call centers for administrative questions. Also, firms are investing heavily in their online discount brokerages, so you’ll find excellent resources within platform itself.
Robo-advisor online platforms are the second cheapest option. You do not have to make all the decisions with this platform. – you have algorithms (hence ‘robo’) to help. You answer a questionnaire about your goals, risk tolerance, timeframe and so forth, and you are assigned an asset allocation based on your answers. In addition to the assigned asset allocation, the Robo-Advisor recommends products. You pay an annual fee and you also pay the annual MER fees for all the investment products. Like online discount brokerages, you’ll typically find helpful resources on these sites. Click here to Read more about Robo-Advisors on this blog post.
Advisors at investment firms are the most expensive option. You can expect a professional who translates your goals, timelines, and risk tolerance into a recommended asset allocation and investment products. Advisors often charge an annual fee. And if you buy mutual funds and Exchange Traded Funds (click here to read more about ETFs on this blog post), you will also pay the MER, as with all platforms.
Your task: Explore these platforms with an open mind and determine what’s best for you. You are NOT wasting your time going through this process if you continue to work with your investment advisor – you will simply be better-able to provide guidance to your advisor so they can recommend the best investment strategy for you.
Pick Products
If you choose an online discount brokerage platform, you’re on your own with this fully DIY platform, so you’ll do your own research to pick your products. Start with a tool such as Morningstar Canada Fund Screener, which is helpful for revealing the funds that meet your criteria.
If you choose a robo-advisor online platform, you don’t have to pick your own products because your annual fee covers the recommendation of funds. Remember that you still must pay the annual fees associated with holding those funds.
And if you choose an advisor at an investment firm, you also don’t have to pick your own investment products because that’s included in the service. You simply share the work you’ve done above identifying your goals and how much risk you’re willing to take for each goal, and the advisor recommends products.
The difference between product recommendation from the robo-advisor versus the human advisor could be in the degree of customization the human advisor is able and willing to provide. But chances are good that the human advisor has a standard product offering just like the robo-advisor.
Regardless of the platform you choose, you need a decent understanding of the products in which you’re investing.
You can find standardized documents called fund factsheets online, which give you a good overview of the fund. The factsheets may be prepared by the fund company themselves or by third parties, like Morningstar, who are in the business of objective comparison.
Once you train your eye, factsheets are easy to read and interpret and include information on the fund’s investment objective (growth, preservation or income), strategy they use to achieve their objective (high risk start-ups in Africa, for example, or Canadian government bonds), the risk you can expect (measured in terms of historical volatility of their fund), fees they charge annually, and historical performance of their fund (click here to read about performance measurement).
Your task: Experiment with the fund search function on Morningstar.ca and reflect on your experience.
Your final task: Commit to a goal for one of your investing accounts or all of your investments combined. Research the online discount brokerage owned by your bank (they all have them, and they’re all pretty good) and do a search for robo-advisors – see what you think and decide if you want to give it a try.
