If the shock of recent economic volatility in China caused you to take fright, the key it seems, to restful nights, is to have an adequate financial plan in place which will allow you to bear the rough with the smooth.
“People shouldn’t worry about these events – provided they have a good financial plan,” advises Pat Cooney, head of portfolio management at Davy. “The idea really is that by having a plan and sitting down with your investment adviser and doing proper risk-profiling, you will be putting a well-diversified portfolio in place that’s well able to withstand any singular event,” he says.
This then, should provide you with the comfort of not having to do anything when such market events arise. It’s particularly important perhaps, given the tender state of many Irish people’s ongoing relationship with investments.
Indeed for Daniel Moroney, investment strategist with Investec, the recent volatility has had a greater impact on people’s psyches than it might otherwise have had, given how fresh the financial crash of 2008/2009 still is in people’s minds.
“People are taking what has happened recently and are assuming it will happen again,” he says, but he is quick to point out that the environment today “isn’t remotely similar” to that of six-seven years ago.
As he adds, market corrections “aren’t unusual” and they rarely lead to a massive crash such as that experienced in 2008.
The move towards planning also signifies a move towards proper portfolio diversification, ensuring that a portfolio isn’t over-exposed to any particular geography or asset class.
“As a means of trying to ride out volatility, don’t be over-exposed to any one asset class,” advises George Flynn, associate director at Smith & Williamson.
This desire for diversification is, says Cooney, “the big difference” between now and the Celtic tiger era.
“Back then people were chasing return in a deal-driven environment,” he says, noting that now people are much more cognisant of the need to consider the risk as well.
“People now want to know particularly how it [their portfolio] will perform in a down market,” he says. As he notes, people got an “unmerciful fright” six or seven years ago, so now they’re taking proactive steps to avoid this happening again.
“They can’t control the market, but what they can control is putting a plan in place and taking responsibility and having something as robust as they can”.
This means the financial planning process has moved centre stage.
Assess your risk
These days, risk-profiling is the first step most private wealth managers will insist on.
“Today the investment piece comes last – before it came first,” notes Cooney.
Working out your risk appetite, and your preference – or ability – to take on risk, will then guide your adviser into preparing a portfolio that best suits you.
“We put a lot of time and effort into making sure clients do think about their risk profile,” says Moroney, noting that for a private investor, it’s about avoiding speculative and/or leveraged investments, and looking to get the asset mix right.
Know your goals
“People are far more realistic,” says Cooney about return expectations, noting that in a survey of Davy’s clients, return on portfolio didn’t feature in the top five most important issues.
“What is most important to them is transferring wealth in a tax-efficient way to future generations, protecting themselves and families from unforeseen events, and making sure that their assets are working together to achieve their financial goals”.
Flynn agrees that preservation of capital in real terms is key for clients.
“Their biggest concern is that not only in 10 years time will their principal be there, but it will also be there in inflation-adjusted terms,” he says.
Ensuring you’re on track to meet your goals is also important, but, while Cooney acknowledges that it is prudent for clients to be involved with the planning process and not to delegate away entire responsibility, he warns at the same time that getting “overly engaged”, and checking valuations on a daily or weekly basis may possibly not be the best way to approach it.
Having an update three or four times a year should suffice, he says.
Be aware of the challenges
While recent volatility may have shaken many investors, it’s not the only challenge they face, given low interest rates and fixed-income products which have become riskier.
As Moroney notes, if you put money into a 10-year German bund today, you will get your original investment back at the end of the term. However, in the meantime you will have got an annual income of less than 1 per cent, which will be a risk if inflation starts to pick up.
“The hardest thing from our perspective is to try and manage money for lower-risk investors,” he says, adding that a goal at Investec is to try and identify alternative sources of income that don’t run the risk of investors simply chasing yields.
“Traditional low-risk assets, such as AAA government debt are yielding next to nothing, and in some cases offering a negative return. It’s a huge challenge to replace that level of return,” agrees Flynn.
One approach for low-risk investors is to keep money in cash. “It’s very prudent at times like this to maintain a healthy cash balance. It’s important to remain patient and not have a knee-jerk reaction into something that looks more attractive,” advises Cooney.
Fortunately inflation is not yet a factor, but this may change and keeping large amounts on deposit is not a good long-term solution.
“Your money will end up dwindling away over time once inflation normalises,” notes Cooney.
Another challenge is meeting investors’ return expectations. While these have been re-calibrated since the heady days of the boom, there can still be a mismatch.
“People can still have somewhat unrealistic expectations; people want return, but they don’t want to take much risk either and that’s hard,” notes Cooney. The risk then, is that people with a low-risk appetite may find themselves seeking out the holy grail of return – without paying due caution to the risk that they are taking on.
“If investors are looking for a stock market return, they will have to have 100 per cent exposure to equities – and with that brings volatility,” warns Flynn, adding that it’s beholden on professional advisers to discourage low-risk investors from doing that.
The inheritance tax conundrum
The slashing of inheritance tax thresholds in recent years has brought home how important good financial planning is for everyone – and not just the rich.
Figures from the OECD show Ireland has one of the toughest inheritance-tax regimes in the world, with children entitled to inherit just €225,000 tax-free from their parents – down from €540,000 in early 2009.
While this may seem a substantial sum, it is not unusual for someone, particularly in Dublin, to leave an estate of €1 million or more, given the recovery in property prices. With such low thresholds, people then have to think carefully about how to structure passing on their wealth.
“Nobody wants to pay an inordinate amount of tax and some sensible planning can help minimise this tax liability,” notes Investec’s Daniel Moroney.
There may be some relief on the horizon, however, with the Government expected to make some concession to the regime in the forthcoming budget in October. It may increase the tax-free threshold, or it could introduce special relief for the family home, as is the case in the UK.
