Here we are at session number 61 , and we’re going to be talking about the Three T’s of Intelligent Investing.

OK, so three T’s. I mentioned them briefly a couple of weeks ago which prompted the thought and which I have painstakingly developed and stretched out to fill an entire show this week. The idea is that you have to have a point for investing; an intention, a reason for putting money away and investing it in a given way. The three T’s give some structure to that and will hopefully help you to focus your thinking if you’re at the point of making an investment or are about to review your existing portfolio.

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But first…

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Everything you need to KNOW

So, let's look at what you need to know about the three T’s to make them work for you.

1 – The first T is for Target

If you’re going to work towards anything, you need to know what it is you’re heading towards! Most of us will recognise the famous quote from Lewis Carroll’s Alice’s Adventures in Wonderland: “If you don’t know where you are going, any road can take you there.”

That might sound ideal on the face of it, but that’s just the mad world of Wonderland talking. In the real world, if you don’t know where you’re going, either you’ll just set off and rely on sat nav, which might be a bit touch and go, or you can plan a route in advance, which is infinitely preferable.

The fact is, you have to know where you are going, other wise you’ll never know when you get there.

When it comes to investing, a target can be defined in a pounds and pence figure, as in, I want to have saved £25,000 in the next five years. Often it will be expressed in terms of an income: I want to have enough money invested to produce an income of £X per month. Both of these work well enough.

It can be difficult to be precise. In fact, it’s arguably impossible to be precise and the further ahead in time your target lies, the more difficult it is. There are some pointers for this though, which I’ll get to in the next section. But having a target is essential for intelligent investing.

2 – The second T is for Timescale

Not only do you need to have some idea of what you’re aiming for, you need to know when you need to get there. This is fundamental because your timescale informs other factors:

Amount – If you’re saving monthly, we need to know how many months we’ve got so we can determine how much we need to save each month.

Annual growth rate and therefore risk – We need to divide the growth rate by the number of years in order to see how the money should be invested. So if we need to double the money in ten years we know how to invest to do that. If we only need to increase the money invested by 60%, then we can work that out too.

Certain timescales are more fluid than others. For instance I have no idea when or if my daughters will get married, but I have a better idea of when they go to university, if they choose to do so. It’s certainly easier to work towards a defined point in time, but it’s not always easy or even possible to know that for sure, in which case you have to take a stab at it and come up with an approximate timescale.

Knowing the time you have to work with allows you to pace yourself and if necessary, build up over time. It also gives us a timeline to set up mini-targets along the way, which may well help you retain focus, particularly over the longer timescales.

3 – The third T is for Tolerance for Loss

Broadly speaking there are two elements to investment risk. The first is what advisers call attitude to risk, which is how you as an investor might feel about risk. I often put this into fairly stark context when talking to a client, saying something like: “If I come back here a year from now and you’ve lost 20% of your money, how much are you going to want to kill me?!” Obviously I’m putting a bit of lightness into it there, but it becomes even more stark if you move away from percentages and into pounds and pence.

So I might ask, if someone is investing £100,000: “If I come back here next  year and your £100,000 is worth £85,000, how would you feel?”

The second element to investment risk is not about feelings, but about tolerance or capacity for loss. In other words, it’s about how much you can afford to lose without it causing serious problems for you.

In this third T I’m lumping the two together really. Knowing your attitude towards risk and tolerance for loss directly informs the kind of investments you should be making. There is a whole science behind investing towards a given level of volatility, which is probably outside the scope of this session right now, but for a bit more info and a general discussion of risk, listen back to Session 16.

Summarise KNOW

These three T’s then are:

#1 – Target

#2 – Timescale

#3 – Tolerance for loss

It’s a bit contrived, I’ll grant you that, but hopefully it focusses the mind when considering any new investment. Now, let’s look a how to apply these to a practical situation.

Everything you need to DO 

1 – Make  sure your Target is realistic, inflation adjusted and keep it loose

Obviously any target has to be within striking distance or you might as well not bother. Realistic doesn’t mean lowly however; a goal worth hitting does require some effort on your part. If you’re contributing monthly to this goal, make sure that the level of savings you decide on is sustainable. Build it into your budget before you pay any bills and make sure you can continue to do so, minor emergencies notwithstanding. If you are investing a lump sum, make sure that you have allowed enough accessible money so that you won’t have to dip into this investment if the boiler needs replacing or something similar.

The most important thing to remember when planning ahead is always to express your targets in today’s money, that is, with inflation taken into account. This is easier to do than you might think, at least in a scratch, rough calculation kind of way.

There are some calculators on the Hargreaves Lansdown website here: http://www.hl.co.uk/news/calculators/regular-savings-calculator

The middle tab on the website allows you to enter the amount you’re looking to achieve and will work back to tell you how much you need to save each month. To take into account the effect of inflation on your regular savings pick a growth rate, say 6% per year which is achievable for a balanced investor, and then take the inflation rate off that, say 3% for argument’s sake, which gives you a net of inflation return of 6-3 = 3%.

Like I said, this is very scratch, but it serves a purpose. If you’re handy with Excel this is easy enough to do.

But make sure your target is expressed in the right way, with inflation taken into account and make sure it’s doable. Be prepared to hold it loosely if life gets in the way. We’ve talked enough about preparing for emergencies on this podcast, so I’m assuming you have an emergency fund in place and that your debt is at least under control and ideally paid off. Holding anything loosely means it can be shifted if necessary.

2 – Remember some timescales are set and some are flexible – build in some flex?

Like I mentioned before, I have no idea if or when my daughters will get married, but I can have a pretty good stab at the time they’ll go to university, give or take a year. Give some thought to your timescale. Is it set in stone or can it be moved if necessary? Obviously, flexible timescales are useful if certain other variables don’t work out, like the desired rate of return isn’t achieved.

In fact, a wise planner would build in some flex to their timescale because they know that life doesn’t always go to plan. If there is an absolutely set-in-stone date that you are working to, like maybe state retirement age, I think I would plan to hit my target two years before so that I had some slack built in, just in case something didn’t quite work out. That might seem defeatist, but there are too many variables, and usually the timescales are quite long, so it pays to keep that in mind.

3 – Choose a risk-rated fund or build a risk-rated portfolio

Risk is an inexact science. The ideal scenario is to have a blend of funds which performs exactly within tolerances for volatility (the ups and downs) and expected returns (how much money you’ll make over time). Again, life does’t work like that, but you can radically improve the predictability of your returns by taking some time to build a risk-rated portfolio.

If you’re starting out, I strongly recommend, as I always do, that you look for a risk-rated, multi-asset fund to do the heavy lifting for you. These funds invest across all kinds of different assets like shares, bonds, property, commodities and all that jazz, and they keep the weights across these asset classes constantly under review to make sure the fund is performing as expected. These funds usually have names like balanced or moderately adventurous, and so give you some idea of how they might behave. Often, the fact sheet for the fund will show past performance and you should be able to see the levels of ups and downs experienced but he fund in the past. Always remember that golden caveat though: Past performance is no guide to future performance.

Using an off-the-shelf fund makes life easy, but if you fancy putting together a portfolio yourself, then this page from Distribution Technology might help you. It lists the ten standard risk ratings that DT have devised and if you click each one it’ll give you a list of funds which match that risk profile. You can then use these lists to go away and do your own research as to how each of these funds has performed. Remember if you do this that you must keep that portfolio under review. That’s why I like the off-the-shelf approach; it’s less work!

4 – Bear in mind lifestyling, and don’t be greedy

It’s essential that as you approach your target date or your target pot of money that you bear in mind that a last-minute blip in the markets could be the difference between you hitting your plans or missing by some margin.

Many advisers, when working towards given targets with clients, adopt a process called life styling. Many pension schemes have this built in. The idea is that the closer you get to your target date, the risk of the portfolio is adjusted downwards to minimise the impact of a last-minute market shock. This makes sense, but I prefer to manage this manually, rather than let a computer do it. Why? Well let’s say markets are roaring away and your  investment is performing better than expected, it seems a shame to switch out of the well-performing market simply because an arbitrary date has rolled around. Worse, if the market is down a bit and the date arrives to switch out, you could be doing so at a loss, which seems daft.

Just be aware that as you get close to your key date, your available time to fix any mistakes is vastly reduced, so take steps to minimise the impact of this.

And, if you’re lucky enough to hit your target two years early, don’t be greedy. I would reduce the risk of my portfolio significantly to lock in the money I have, still allowing for a bit more growth, but reducing the chance of loss too.

Summary

So then – Three T’s. Hopefully that focusses your mind a bit. There are some difficulties that many people will find a struggle, not least expressing things in today’s money, but as ever, a competent financial planner can help with this. I’d love to be able to help you all but there are only so many hours in the day!

Common sense should prevail. If nothing else, the thought process of choosing a date, and identifying a target amount will be a good step forward for many people. Most folk I come across just save or invest in a blind, hopefully-it’ll-be-enough-one-day kind of way. Don’t let that be you. If you have any questions, leave them [in the comments section below] at the show notes: meaningfulmoney.tv/session61

This week’s reviews

Competition winners! Many thanks for the flurry of reviews received in the last week – 8 in all. Only five are winners of the books though. I’ll read these five out and carry the rest over to next week.

[Read the reviews]

Now, John B, Steve13579, Only Willis and Boyaxxa, I need you to email me on pete@meaningfulmoney.tv with your mailing address. If you did this last week I’m sorry. My email has been doing slightly weird things lat week, I think due to a clashing app on my iPhone messing with the synchronisation – bad workman blaming his tools and all that. I need your postal address to send you the books guys, so let me know as soon as you can and I’ll have a Meaningful Elf send them out.

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News

Weight loss report – Stayed the same at 17st 4.5 lbs. Anyone else getting frustrated?! I have never found it so difficult to shift weight in the past, I normally lose a stone in four or five weeks once I get going. Be assured of my diligence folks. I did go to London for three days last week, but I didn’t do my usual total indulgence so it is all a bit weird. I did go for my first run in two years this week, since tearing cartilage and having to have surgery. It wasn’t fast and it wasn’t long, but hopefully it’s a start. I’ve no designs on ultra marathons, or anything, but I’d like to be able to do three miles, twice or three time a week. We’ll see. Thank you or bearing with me folks!

Next Session Announcement

Next time we'll be talking about the new Mortgage Stress Testing. In April a new set of rules governing mortgage advice and provision came into play. As a result, there are already reports of much more invasive questions about spending habits and stress tests such as whether you would still be able to afford the mortgage if interest rates rose significantly. If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/feedback

Outro

That's it for this session of the MM podcast, I hope it was helpful. If I missed anything or if you have any questions, please leave them comments section below.

I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.