First time investor advice

Your investment policy - basic principles to take into account when accessing investment policies.

Normal, long-term relationships between asset classes - investment strategies and recommended asset allocations based on the normal, long-term relationships between asset classes.

Psychological aspects - the Bailard, Biebl and Kaiser personality classification model describes one´s willingness to accept investment risk from a psychological point of view.

Your investment policy

Your investment policy should address seven basic issues:

Risk tolerance

Fundamental to your approach is to assess the degree of risk to which you are willing and able to accept. This is the first step in the process because your potential return is dependent on the risk taken.

Return requirements

Is it the primary consideration for you to have current income, long-term growth or is it to preserve principal in nominal or real terms?

Liquidity

Some assessment must be made concerning how important it is to hold assets that are really marketable. This assessment is based on the need to have a cash reserve, and/or the likelihood that cash may have to be raised quickly to meet some sudden expense.

Time horizon

The portfolio must be managed in a long- or short-term time setting. The longer the time horizon, the more possible it is to rely on efficient market concepts and the normal relationships. The approach presupposes that equities perform better than bonds, and that bonds perform better than cash equivalents over the long term. As the time horizon shrinks, the current outlook for the relative performance of the various asset classes takes on greater significance.

Taxes

The influence of tax on your portfolio must be analysed and optimised. The basic objective must be to choose strategies that will optimise after-tax returns.

Laws and regulations

You have to take any legal constraints, such as trust deed provisions etc., into account when compiling the portfolio.

Unique preferences

Any special circumstances that may exist must be taken into account, for example whether it is an estate that you are investing for.

The strategies and the recommended asset allocations should be tailor-made to meet your circumstances, but they are usually based on the following normal, long-term relationships (and never on the current ´real world´ outlook for the various classes of assets.)

Normal long-term relationships between asset classes


Equities have a higher expected rate of return than bonds, but are more risky. Equities also offer more inflation protection than do fixed-income investments, like bonds (government and others) and bank deposits.

Bonds have a higher expected rate of return than money market instruments (primarily bank deposits), but they also carry more risk than money market instruments.

Money market instruments have the lowest expected rate of return, but they also have the lowest risk and are the most liquid of all the asset classes.

Foreign investments are good ways of reducing risk through diversification because their returns are not highly correlated with those of domestic securities and the domestic currency.

Real estate offers rates of return that are comparable to those offered by other equity investments with about the same level of risk. Real estate is also a good inflation hedge. However, real estate is liquid and often must be purchased in large blocks. Real estate is a good vehicle for reducing risk through diversification because its returns are not highly correlated with those of other asset classes. Interest rates, however, do play a major role in the value of properties.

Venture capital investments offer potentially very high returns but with considerable risk. Like all equity investments, venture capital offers protection against inflation. It is also very illiquid. For those who can tolerate the illiquidity and the extraordinary risk, venture capital is a good diversification vehicle because its returns are not highly correlated with those of other asset classes.

Collectibles and commodity-type assets such as gold, rare coins, stamps, antiques and art are generally outside the purview of the typical investment portfolio. These investments are generally good inflation hedges but they are usually illiquid (an exception being precious mertals). One drawback of these investments is that it usually costs money to hold them in the form of storage costs, and insurance, in contrast to other investments that often pay a current return in the form of dividends, interest or rent. The returns on collectibles may be high but so is the risk. Because of their illiquidity, there usually is a large spread between the bid and asked quotes.

Tax-free investments should be considered for investors in high tax brackets. Always attempt to maximise your after-tax return.

As long as a long-term time horizon is assumed, these relationships can be used as the basis for determining the appropriate asset mix for you, the investor.




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