week 1 presentation - learn how to invest · week 1 - risk, volatility & timescale week 2 -...
TRANSCRIPT
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Agenda
Week 1 - Risk, Volatility & Timescale
Week 2 - Asset Allocation
Week 3 - Identifying the Building Blocks
Week 4 - Reviewing a portfolio
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Risk, Volatility & Timescale
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Key Risks
Inflation Risk - Reduction in buying power of money
Longevity Risk - Risk that you’ll outlive your money
Inertia Risk - Risk that you’ll miss out by doing nothing
Investment Risk - Risk of financial loss due to markets or provider failure
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Key RisksInflation Risk - Reduction in buying power of money
£
5% Growth
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Key RisksInflation Risk - Reduction in buying power of money
£
3% inflation
2% Net Growth
Fix: Invest to grow ahead of inflation
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Key RisksLongevity Risk - Risk that you’ll outlive your money
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Key RisksInertia Risk - Risk that you’ll miss out by doing nothing
Start February April June August October December
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Investment Risk
Definition Chance that an investment’s actual return will be
different than expected. Risk includes the possibility of losing some or all
of the original investment
100% chance of investment risk!
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Investment RiskRisk of provider failure?
• Always possible - remember Lehman Brothers• Major provider unlikely to be allowed to fail• Only way to be sure: < £50,000 FSCS limit• Know where your money is held
★ 3rd party nominee?★ Own nominee?★ Will be separate from operating expenses of
provider
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Investment Risk
Markets
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Investment RiskIMPORTANT
If the value of an asset you hold is reduced, this does NOT constitute a loss.
A loss is only experienced when you sell the asset
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Investment Risk
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Investment Risk
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Investment Risk
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Investment Risk
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Investment Risk
How much can you afford to lose?
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Risk Tolerance &
Capacity for Loss
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Risk ToleranceYour ability to cope with financial shocksMore about emotional response than your
financial capacityCan you disregard external input?
At what point will you start to worry?At what point will you bail out of the markets and
crystallise your losses?
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Risk ToleranceYour ability to cope with financial shocks
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Risk ToleranceYour ability to cope with financial shocks
Relative ability to cope is irrelevantRisk is an abstract concept
Real money and real life matterCheck out
meaningfulmoney.tv/myrisktolerance
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Capacity for LossHow much can you afford to lose?
Remember loss is only on crystallisationNo-one loses ALL their money, unless taking big
betsHow much are you investing relative to total
wealth?
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Capacity for LossHow much can you afford to lose?
Total liquid wealth: £250,000 Amount to invest: £25,000 = 10% of total
50% loss on that = £12,500 Which equals 5% of total wealth
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Capacity for LossHow much can you afford to lose?
Total liquid wealth: £250,000 Amount to invest: £200,000 = 80% of total
50% loss on that = £100,000 Which equals 40% of total wealth
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Cautious Moderately Cautious Balanced Moderately
Adventurous Adventurous
Expected Return 4% 5% 6% 7% 8%
Max expected 1yr Gain
14% 17% 24% 32% 36%
Max expected 1yr Loss
-4% -6% -10% -14% -17%
90% certainty - as good as it gets!
Capacity for Loss
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1 Year Balanced £100k invested
Expected Return 6% £106,000
Max expected 1yr Gain 24% £124,000
Max expected 1yr Loss -10% £90,000
Capacity for Loss
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3 Years Balanced £100k invested
Expected Return 6% £119,101
Max expected 1yr Gain 24% £190,000
Max expected 1yr Loss -10% £72,900
Capacity for Loss
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Capacity for Loss
This should help you to answer the questions: • How much fluctuation am I happy with? • How much can I afford to lose?
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Timescale & Risk
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Timescale & RiskAccumulation Phase
Timescale Risk Level
< 4 Years Risk-free
4 - 5 Years Risk Profile minus one notch
5 - 10 Years Risk Profile
> 10 Years Risk Profile plus one notch
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Timescale & RiskAccumulation Phase - Balanced Investor
Timescale Risk Level
< 4 Years Risk-free
4 - 5 Years Moderately Cautious
5 - 10 Years Balanced
> 10 Years Moderately Adventurous
5 Year investment: Moderately Cautious
8 Year investment: Balanced
20 Year investment: Moderately Adventurous
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Timescale & RiskDecumulation Phase
Timescale Risk Level
< 2 Years Risk-free
2 - 4 Years Risk Profile minus one notch
4 - 8 Years Risk Profile
> 8 Years Risk Profile plus one notch
Money you’ll never need Take your pick
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Timescale & RiskSegmentation
Accumulation DecumulationTimescale Risk Rating Timescale Risk Rating
< 2 Years Risk-free < 2 Years Risk-free
2 - 4 Years Risk-free 2 - 4 Years Risk Profile - 1
4 - 5 Years Risk Profile - 1 4 - 8 Years Risk Profile
5 - 10 Years Risk Profile > 8 Years Risk Profile + 1
> 10 Years Risk Profile + 1 Money you’ll never need Take your pick!
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Timescale & RiskDecumulation Phase
Essential not to take too little risk in the decumulation phase.
Traditional Lifestyling is not fit for purpose
Exception: Annuitisation
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Timescale & RiskSegmentation - Example
Savings for Christmas, holiday, new car - zero risk (<1-2 years)
Saving for daughters’ university costs - balanced risk (Begins in 2.5 years for possibly 6-8 years)
Retirement Savings - adventurous risk (>15 years)
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Timescale & RiskSegmentation
Most of us don’t have lots of different target potsEasy to segment using wrappers
Or segment using investment choicesOnline platforms make things easy
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Risk Measures
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Risk MeasuresVolatility
Definition: How much a fund deviates from its average
Problem: Calculation methods not always obvious
Simple exampleAverage return: 5%
Volatility = 15Range = -10% to +20%
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Risk MeasuresVolatility
Definition: How much a fund deviates from its average
Problem: Calculation methods not always obvious
Another simple exampleAverage return: 5%
Volatility = 5Range = 0% to +10%
Not a great measure, but nominally useful
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Risk MeasuresSharpe Ratio
Definition: Amount of excess return per unit of risk
Excess return? Over risk-free rate, eg cash or govt bonds
No good or bad Sharpe ratio; it’s a comparison
Higher is better
Negative Sharpe = better off in cash!
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Risk MeasuresSharpe Ratio
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Risk MeasuresSharpe Ratio
Two funds: Fund A & Fund B
Fund B has higher Sharpe Ratio
Fund B has has achieved higher return, while taking no more risk than Fund A
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SummaryDifferent kinds of risks
Investment risk - when is a loss not a loss?
What matters is when you need the money
Risk tolerance & Capacity for loss
Timescale & Risk
Risk Measures for fund choice
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Timescale & RiskSegmentation
Accumulation DecumulationTimescale Risk Rating Timescale Risk Rating
< 2 Years Risk-free < 2 Years Risk-free
2 - 4 Years Risk-free 2 - 4 Years Risk Profile - 1
4 - 5 Years Risk Profile - 1 4 - 8 Years Risk Profile
5 - 10 Years Risk Profile > 8 Years Risk Profile + 1
> 10 Years Risk Profile + 1 Money you’ll never need Take your pick!