By Mr. Alijeffty C. Gonzales, CIS , RFP®
Please allow me start off this discussion with a disclaimer: I am writing this as a Registered Financial Planner that aims to provide some useful insights to individual investors on how best to design an investment portfolio to help them achieve their financial goals, while I may be mentioning some financial concepts/strategies that I normally rely on in my dealings with various investment banks in the course of my “day job” of which I am involved in the design and marketing of structured financial products, I find these concepts very relevant even on a personal finance level and would like to share it, hope the reader will pardon the occasional technical terms.
The success or failure of our investment activities will rely mostly on three key factors: the amount of money you have set aside for investments, the consistent rate of return that your investment vehicle delivers and time horizon – the time you left your investment aside to grow.
Amount of money set aside for investments.
This is normally the most difficult part of the personal investment management process as it involves a lot of decisions relating to how we may need to cut down on immediate gratification both for yourself and your loved ones. Saving money today seems to convey a negative impression of holding back on the good things you’d like to provide yourself and your family.
As a breadwinner myself I am almost always in a situation where I feel inadequate as the primary family provider if I start to set conditions on what can be bought and what can be enjoyed today. A helpful insight is to recall the lesson from the “Marshmallow Experiment” (//en.wikipedia.org/wiki/Stanford_marshmallow_experiment), a study on deferred gratification conducted in 1972 by psychologist Walter Mischel of Stanford University, which shows that deferring consumption today will mean that I can provide more for my family in the future, thinking of it this way makes it an easier decision.
The math in this first factor is very straightforward; the more money you can save today will greatly increase the chances of your achieving the money goals needed to fulfil financial goals.
Consistent rate of return, with emphasis on “consistent.”
As a practising Registered Financial Planner, I have been asked on a lot of occasions by clients on what would be a great investment; it’s as if choosing the investment that generates the largest returns will ensure investment success. My standard answer is that how I wish I have a “crystal ball” that can foretell the future, being somebody who has a healthy respect for market risk and the writings of Nassim Nicholas Taleb of The Black Swan fame, I am of the belief that no matter how hard we analyze present circumstances with the objective of predicting future market trends, it would still be a futile exercise as NOBODY has consistently proven that they can beat the market all the time.
In the absence of an accurate predicting capability, what could be a prudent way of choosing investment vehicles that would deliver the medium to long-term growth returns that we need.
In my involvement in the design of structured investment products, the requirement to test out the validity of an investment strategy is done through the running of the actual strategy on a set of past data normally stretching to at least the last 10 years. The rationale for this is the observed normal distribution of price change based on the probability theory used in institutional fund management indicates investment vehicles have an average annual return. In layman’s terms, investment vehicles grouped together in terms of asset class have shown a measurable expected rate of return, which is basically its historical return over time. While this may not be accurate 100% of the time, it can be relied on for projection purposes 68% to 95% of the time.
Having said this, this is the historical returns of US stocks and bonds using data covering the period from 1928 to 2011 is 11.20% and 5.41%. (//pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html).
Assuming that you subscribe to the idea of traditional asset allocation between stocks and bonds, this can be a useful tool in estimating the probable value of your investment funds over time, this data set can also be used in determining how much you need to set aside and invest to achieve using the discounting method.
The standard recommended allocations based on the time to your financial goals are:
- 2 to 5 years to your financial goal – 20% bank deposits, 50% bonds, 30% stock
- 5 to 10 years – 10% bank deposit, 45% bonds, 45% stock
- 10 to 15 years – 5% bank deposit, bonds 20%, stocks 75%
- More than 15 years – 5% bank deposits, bonds 5%, stocks 90%
These are just rule of thumbs, to get a more appropriate allocation I would suggest you consult with your financial planner/adviser as other factors like your personal financial circumstances, the level of risk you are comfortable with among others should also be considered.
Among the three factors, time horizon can be said to be the factor that would work in your favor most of the time.
Albert Einstein was believed to have said the “compound interest” is one of the most powerful forces of nature. For our discussion purposes please allow me to paraphrase this from compounded interest to “compounded return” as compounded interest may be misleading us to believe that the benefit of compounding only comes from interest bearing vehicles.
Applying this means we have to start investing as soon as we can. To illustrate, a 25-year old investing P10,000/month for 10 years will have P19 million by the time he retires as age 65 assuming a consistent rate of return of at least 8.0% per annum. A 30-year old will have P6 million less and a 35 year old will have just P8.8 million or less than half the retirement fund of the 25 year-old that started earlier.
Another way to look at this is the affordability of setting aside money for retirement for example, taking off from our illustration above, if a 25-year old can do so with P10,000/month, a 30-year old needs P17,500 (75% more expensive) to get the same amount of retirement money while it would a 35-year old P28,000 making it 180% more expensive.
In closing, there is no secret formula nor short cut in achieving your financial goals from investing, while some people might be lucky enough to become overnight millionaires by winning the lottery, most of us common mortals will have to rely on the old, boring but reliable way of saving and investing.
Mr. Alijeffty C. Gonzales, CIS , RFP is one of the pioneer of RFP in the Philippines, he is the facilitator of the Investment Planning Module ever since the very first RFP class several years ago.
A graduate of the Management Development Program of the Asian Institute of Management where he finished with a Superior Rating and a recipient of the Father James Donelan Prize for the Most Outstanding Strategy Presentation.
He has served as senior executive to several financial services companies and is currently the Vice President and Head of Business Development for INSULAR LIFE, the largest Filipino Life Insurance Company where he is actively involved in the design, marketing and distribution of Structured Variable Universal Life products; these provides policyholders with access to a diversified, strategic and fully managed global investment portfolio, life insurance and 100% principal guarantee if held to maturity.
Mr. Gonzales maintains a personal blog (www.acgadvisors.net) where he shares his insights and materials from the public seminars he regularly conducts.