In the previous post, we looked at what you need to do when it comes to moving from goals to actions. We'll look at the last few steps here.
Set Your Investment Approach
Right, let’s get practical. We have our MT goals and in working out what we need to do, we have assumed an investment return. We need now to invest in such a way as to aim to get that return. The problem is that no-one knows how shares, bonds and so on will perform in future, so we’re guessing.
I have created some sample asset allocations which serve to show how different allocations have performed and show that historically at least, a higher equity content leads – over the long term – to higher returns.
DISCLAIMER – this is not advice. I have no idea if these are right for you. They are only examples, because there is no RIGHT allocation.
Do not use past returns to set your targets; instead we’re going to set some benchmarks. Over the past ten years, the sample asset allocations have exceeded the benchmarks but the past ten years have been weird, fuelled by unprecedented monetary policy coming off the back off the financial crisis.
The ten years prior to that, approximately 1999 to 2008, were VERY challenging, with two major crashes in that time. We’ll ignore actual past returns because, as we’ve said they are not guaranteed to be matched in the future.
I have five asset allocations – Cautious, Moderately Cautious, Balanced, Moderately Adventurous and Adventurous – and to each of these I attach a target return (not an expected return), as follows:
Cautious – 4%
Moderately Cautious – 5%
Balanced – 6%
Moderately Adventurous – 7%
Adventurous – 8%
Take a look at how you’re invested now. Which of the sample allocations does your current portfolio most reflect? From there, you may decide to take that assumed percentage return to set your target return for your goals setting.
Example: Let’s say you’re invested in the Vanguard LifeStrategy 80% Equity Fund, which fairly closely reflects the Adventurous sample allocation. You might say, ‘Given that I’ve assigned a target (assumed) return of 8% to that Adventurous portfolio, this might be the figure I use to work out my goals and actions.’
If you’re at the Planning with Purpose stage, you’ve established your risk profile, you understand the link between risk and returns, and you’re comfortable with volatility. As you know the risks, you know there’s no guarantees. These are simply guidelines for making assumptions on future growth.
Keep it Simple with Pots
From a 40,000-foot perspective, the only other thing we can do is to simplify our lives with some kind of ‘pots’ approach to meeting our goals, although to an extent this might affect your choice of tax wrappers.
Most of us will have one major goal of – to reach FI one day. Think of this as a pot we’re going to need in addition to any secured income sources we have, such as DB pensions, the state pension, rental income from property etc.
We have our secured income level, probably coming in at different points, and we will probably have a gap between that and our desired expenditure level, so we need to fund it with capital, and we’re going to need to save it up. When we have enough capital to fund the gap between our secured income and our expenditure, we’ve cracked it.
Then we may have some smaller goals along our timeline, like providing for school fees, help with university, big holidays or buying a camper van. I suggest that for these smaller goals, you think of these as pots of money too. Most of us won’t have many. Whether or not your goals are provided for by actual, physical pots of money depends on your view, but I actually really like that approach.
I want you to identify how many pots you might need in addition to your big pot for FI, and then identify an investment approach for each pot based on your timeline. Chances are your FI pot will have multiple moving parts, but the smaller goals probably can be much more straightforward than that.
There’s not much else we can do to set our actions and take the high-level approach to wealth-building. Most of our decision-making happens on the ground, day-to-day. Setting the investment approach is high-level; which pot you hold that money in is a ground-level thing.