Investment Planning

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Our investment philosophy

1. Stock markets work on the basis of capitalism. Investors provide capital to companies and expect to earn a positive return. The return depends on the nature of the companies that are invested in and the risks they take. 2. With so many investors in the market and with the amount of information available, we believe markets are efficient. The current price of a share therefore reflects the available information in the marketplace. It is therefore very difficult to pick companies and fund managers that will consistently out-perform the benchmark over time. 3. Return is related to risk. The greater the risk of an investment the greater the expected return both to the upside and downside. Various asset classes have different risk characteristics. For example UK Equities have more risk than one month Treasury Bills, but have produced a higher long term return. 4. Historical evidence indicates that the longer the timescale the more likely it is that equity investments will outperform interest-generating investments as time tends to smooth out the effect of positive and negative price movements. Although there is no guarantee of this, the longer term investor is able to have a greater degree of confidence that greater expected returns of equities might be achieved. 5. From the above therefore, the expected return from a portfolio is related to the risk of that portfolio, and the risk of that portfolio will be determined by the asset mix. Those portfolios with a greater equity content will have a greater expected return versus one with more of cash or bond content. By increasing the bond content of a portfolio the expected return will be less but so will the volatility or risk of that portfolio. 6. It is difficult to time when to buy and sell any market. Using Strategic Asset Allocation to match the risk profile of a client with an appropriate asset mix i.e UK and International Equities, Bonds, at low cost is a preferable long term investment solution. For a variety of reasons, many investors do not have a good investment experience and our process helps to minimise that risk.

Key Investment Principles

Our investment strategy is to minimise investment risks and costs and help provide a good investment experience. Some of the key principles we follow are: 1. Diversification – investing across a broad range of investments 2. Investing for the long term – to avoid the short term volatility of the market 3. Avoiding investing emotionally – which tends to lead to buying high and selling low 4. Investing regularly – which avoids investing at any particular peaks in the market 5. Avoiding timing the markets – timing markets is for gamblers rather than investors 6. Rebalancing – reviewing investments in line with your stated risk tolerance 1. Decide how long you want to invest – short, medium or long term The first step with investing either lump sums or monthly amounts is to split the investment into short, medium and long term. This then helps to start building a structured investment programme. Short term can be considered anything up to 5 years Medium term is typically 5- 10 years and Long term is 10-15 years plus This decision as to when you might want access to the money can help determine what investment vehicles you should use, such as Bank accounts, Individual Savings Accounts or Pensions and what asset classes to use, for example Cash, Bonds, Equities, or Property. 2. Measure your risk tolerance Your risk tolerance is your emotional and financial ability to withstand short term declines in the value of your portfolio without succumbing to the urge to sell at what could be the wrong time. Types of investment risk Capital Risk when investors talk about risk it is probably safe to say that most will be concerned about the risk to their invested capital ie ”can it go down, how far might it fall” and whilst capital risk clearly exists, the fear of investing in real assets due to the risk of capital loss can often result in investors missing out on ‘real returns’. Liquidity Risk: Too many investors get caught out by having insufficient access to short term funds, being forced to sell invested assets at the wrong time. Inflation Risk: The concern that money will lose its real value in relation to inflation over time. Market Timing: Too many investors try to forecast the highs and lows of markets and often end up being out of the market during the periods of the best returns. The Finametrica Risk Profiling system that we use is a sophisticated tool and helps us to determine what level of volatility you are prepared to accept. This ‘score’ enables us to identify a suitable asset allocation. To read more about this system please click here Understanding the Finametrica Risk Profiling System 3. Asset Allocation Once we understand your tolerance to investment risk we can then begin the process of determining how we can structure a portfolio to ensure optimum returns within the parameters set by the risk profiling ‘comfort zone’. Different asset types tend to rise and fall in value at different times and for an investment portfolio to be successful this diversification is by far the most important aspect of the investment process. Our portfolios consist of three basic asset classes:- 1. Equities (Stocks and Shares) 2. Fixed Income Securities (Bonds) 3. Property Cash is not included in any of our portfolios as all cash required for short term purposes is held in higher interest accounts away from the invested capital to maximise flexibility and returns. 4. Portfolio Selection The Essential Money portfolios are made up of 6 risk graded models. The assumptions underlying their construction are detailed below. • The risk of a portfolio is determined by its asset mix. The lower risk models comprise a greater bond content whilst the higher risk models are 100% equity and property. • As capital is mobile across the globe, over time we believe that all developed markets will have the same cost of capital and hence the same expected returns from their equity markets. • Therefore we weight equally between the UK and International markets in all of the portfolios. • For the higher risk/higher return models, the equity content includes some value and smaller company portfolios, introducing more risk and return to the models. In the longer term both value and smaller companies have out-performed the broader UK market index but at greater risk. 5. Monitoring and Rebalancing Because different asset classes grow at different rates of return, it is necessary to periodically re-balance a portfolio to maintain the target asset mix that is necessary to meet your risk profile. By re-balancing whenever portfolio allocations migrate outside an allowable strategic range, you are enforcing a ‘buy low sell high’ discipline which enhances the long term return for the portfolio. Generally we recommend that re-balancing be considered annually although more regular re-balancing, up to quarterly, is available to investors. Selling assets that are performing well and buying asset classes that are performing poorly may seem to contradict common sense. However re-balancing by definition will involve ‘buying low’ and ‘selling high’. Many investors make the costly mistake of doing the opposite, which can result in lower returns in the long run. Re-balancing allows the portfolio to take advantage of favourable time periods for each asset class, which can often result in a steadier, less volatile performance.

General Introduction to Investing

There are a huge variety of investments available both here in the UK and abroad. They vary based on some of the following criteria

Taxation
Some are better for higher rate tax payers, some for lower rate or non taxpayers
Risk
You can opt to take very little risk or potentially risk all of it. To read more about investment risk and how to measure it Click Here
Geography
You can invest in the UK or eslewhere abroad
Nature
Such as equities (in the stock market), property (bricks and mortar) or bonds (company IOUs)
Structure
Equities can be held directly, through portfolios, investment trusts or open ended structures like OEICS
Flexibility
Some you can surrender immediately, some you have to wait 15 years.
Ethical Nature
Some investments allow you to invest according to your principals and avoid arms, gambling. That's just a few of the areas that we, as independent financial advisers, will look at to find an investment that's right for your personal situation. Perhaps one of the most important areas to consider is your attitude to risk and whether you are prepared to risk losing some of your money in exchange for a higher reward. There are various ways to work this out and we at Essential Money can help you do that. The following short paragraphs help to explain some of the jargon of the different types of investments that you will come across.

Shares

Shares are small stakes in a company. When you buy shares you become a joint-owner of the company along with all the other shareholders. You can buy:
  • existing shares which are already being traded on a stock market
  • new shares when a company first sells them to raise money for its business (for example a stock market flotation, or buying private shares in a small business start-up)

How do you make money out of shares?

The value of shares generally rises and falls in line with the performance of a business. If the company does well you may be able to sell your shares at a profit at a later date. If it doesn't your shares may fall in value or even lose their value altogether. A company doing well may also pay you dividends income taken from its profits. Dividends may rise and fall in line with how well the company is doing, but may not always be paid.

Buying and selling shares

You normally buy and sell shares through a stockbroker. You can ask a financial adviser or investment manager, but they will still deal through a stockbroker. Stockbrokers offer three main types of service:
  • advisory (they give you advice on what to buy or sell)
  • discretionary (they make investment decisions on your behalf)
  • execution-only (you tell the stockbroker what to buy or sell for you)
You can deal with stockbrokers by phone, face to face, over the internet or by post.

Unit trusts

Unit trusts are a type of 'pooled investment'. A fund manager buys shares in a range of different companies and pools these in a fund; you then buy 'units' in the fund. Because the fund contains a range of shares the risk is spread. The fund is 'open ended' - the number of units rises and falls as investors buy and sell units.

The different types of funds

Each unit trust fund has a stated investment strategy, enabling you to invest according to your attitude to risk. Funds investing in 'emerging markets' or smaller companies, for example, would be considered to carry much higher risks than those investing in large UK companies.

Buying and selling units

You buy or sell unit trust units through the fund manager. Their value moves in line with the overall value of the fund, which in turn moves in line with changes to the underlying share prices in the fund. In time you would hope that the value of your units will rise in line with the underlying share values. But if these perform badly the value of the units could fall. You may also get dividend income or interest distributions from your units, based on the dividends or interest paid by the underlying shares or other investments.

Investment Trusts

Investment trusts invest in the shares of different companies, allowing investors to spread their risk. The main difference from unit trusts is that investment trusts are themselves companies in which you buy shares. So you're investing directly, rather than indirectly through an open-ended fund. Because investment trust share prices are affected in part by supply and demand, their value can fluctuate more often than units in unit trusts. As with unit trusts, investment trusts differ in the kinds of companies they invest in - some being more 'high risk' than others. Some focus on capital growth with very little income from dividends, and others invest for a steady income from dividends with some chance of capital growth.

Please note that past performance should not be seen as an indication of future performance, and that the value of investments can fall as well as rise.  Stocks and shares should be seen as a medium to long term investment, for a period of at least 5 years.

EM InvestmentPhilosophy v2.pdf