Inflation, as we’ve said, works against you as you’re building wealth by reducing the buying power of every pound you have, year on year. To guard against the ravages of inflation you simply have to beat it, that is, you have to make your money grow by a rate higher than the level of inflation, so you’re getting richer in real terms every year.
This means accepting market risk as the price of entry for wealth-building. If you’re too afraid of what the market might do to your finances in the short-term, you’ll never benefit from what they could do for you in the long term.
Accepting the fact that your investments might go down on the way to going up is non-negotiable. Markets fall and your investments will too, if you’re invested in such a way as to give yourself a chance of beating inflation. If you’re going to beat inflation, you’re going to experience volatility.
Bu you should push hard for growth, and *in general* you should take more risk with your money than you think. I almost hesitate to say that, but someone’s got to say it. As long as you spread your money around intelligently, and stay on top of things, you won’t lose everything, but you may experience some big swings in the value of your funds. But too much caution won’t serve you.
Very often people’s fear of the markets comes from a position of ignorance. Not wilful ignorance, but a lack of understanding of how things really work. And the answer to that, of course, is education, which is why you and I are both here.
When retirement rolls around, and you’re not likely to be able to add to your wealth any further through working, then it can be tempting to dial back the risk of your investments and pension funds. While this makes sense in the abstract, doing so only gives inflation a foothold. Dialling back the risk to minimise volatility is just asking to underperform over the long run.
Instead you should plan for market risk, accept it as a given and factor it in, and plan for inflation. Factor it in when you construct – and manage – a portfolio. Factor it into your withdrawal strategy too, if you’re in retirement, when you’ll be drawing from assets.
You can give your assets a greater chance to grow if you’re not cashing them into cover your spending needs. Instead you should ladder your portfolio, as we’ve dealt with before, to make sure that in almost every foreseeable situation, you would be drawing down cash or super low-risk investments like Gilt funds perhaps, rather than from the growth engine of your portfolio, the very thing that will help you beat inflation.
One point on this – remember the golden rule not to take more investment risk than you need to. You should probably take more risk than you’re comfortable with, but don’t take more than you need to. This is where planning comes in. With some idea of the returns you need to achieve your aims, you can take an intelligent view on how to invest and harness risk sensibly.
Guard Yourself
By far the biggest factor in your success, financial or otherwise, is your behaviour. The decisions you make and the manner in which you make them is really what it’s all about. As an adviser, I am required by my regulator to try and ascertain my clients’ attitude to risk.
I actually hate doing this because the questionnaires we’re supposed to use are unhelpful, very often. Behavioural risk tools like the Beam app are far better, in my book. The reason for that is that they give me some insight into how my clients might react in certain circumstances.
All the other risk mitigation strategies I’ve talked about here and many more besides are more about making it easier for you to behave well than anything else. They constrain the impact of planning errors and market fluctuations so that you’re not so likely to do something stupid. I covered this in some detail with my friend Neil Bage back in Season 15 – part one is here and part two is here.
For now, though, I just want to drive this point home – YOU are the biggest factor in all this. It’s your choice to save or spend the extra money you’ve just come into. Your choice to invest into a higher risk portfolio than perhaps you might be comfortable with at first. Your choice to educate yourself to better understand this stuff so you ARE more comfortable with a more aggressive investment mix.
And always, your choice how you react. We’re animals, but evolved animals. We can operate from a position of self-control, rather than being slaves to our baser instincts. We’ll never get it anywhere near 100% right, but by pursuing knowledge of abstract concepts and understanding of ourselves and our nature, we’ll comfortably outperform anyone who refuses to do so.
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