Saturday, 29 August 2015

Building a retirement portfolio

Retirement is something everyone should be considering no matter what age they are. But how do you begin to build a retirement portfolio? These 6 steps should help you get started.

1. Figure out what you need. This is particularly important when you reach the age of 50 – by this point you should have a good idea about what your retirement costs will be on a monthly basis and therefore how much money you will need to maintain your desired lifestyle. If you are unsure a good rule of thumb is a minimum requirement of 50% of your current income. If you are under 50 you should be aiming to save around 20% of your monthly income to provide for your retirement.

2. Save more, and extend your working life. The biggest lever you can use to bulletproof you retirement portfolio is to put more money into it, which you can do by saving more. And the simplest way to do that is to work longer. The reality is that most people will not have enough money saved in their retirement fund at 55 / 60 to be able to retire comfortably. By working to 65 you may be able to add a significant portion of savings to help with extra income production on retirement.

3. Diversify. If you want to lower the volatility of your portfolio, diversify within and among asset classes. That means owning funds instead of individual stocks, and owning multiple asset classes instead of just one: a portfolio of emerging markets stock and bond funds, plus domestic stock and bond funds. As always, keep your fees low.

Projected returns for a balanced portfolio of 60 percent stocks and 40 percent bonds over the next 10 years to range from –3 percent to 12 percent, with the most likely scenario between 4.5 percent and 8.5 percent a year on an annualized basis. Equities alone are forecast to have a return centered on the 6 percent to 9 percent range, but with a possible swing from year to year of a full 18 percent. Bonds expected returns are centered in the 1.5 percent to 4 percent range. The translation: You'll probably earn nearly as high returns with a balanced portfolio, but you'll face much less volatility.

4. Design your asset allocation with an eye to taxes. If you have significant holdings outside your retirement accounts, think through which asset classes belong in your retirement account. You'll save significantly on taxes if you keep the equities—which you may buy and sell more frequently as you rebalance—in your retirement portfolio. But don't make your portfolio decisions around your tax savings; maximizing your investment returns and keeping your principal safe is a higher priority. If you are an expat there are several ways to mitigate taxes on investments and future retirement income.

5. Keep a healthy portion of equities. Don't make the mistake of getting rid of all of your equities and shifting into money market funds because you think they are safer. We recommend that in retirement you have at least a 20 percent allocation to equities, often we recommend closer to 50% depending on an individual’s attitude to risk.

6. Relax and set yourself up for automatic rebalancing. You'll be retired for a long time, so in order for your money to keep working at the highest possible pace, you need to continue selling high and buying low, which is what rebalancing automatically does for you. This can be achieved by purchasing appropriate investment funds.

As always, seek advice of a professional where required.

Tuesday, 4 August 2015

How to profit from volatility

Relentless easy monetary policies and short-term bank rates at virtually 0% have kept market volatilities at remarkably low levels for the past few years. Preparing for the next spike may not be such a bad idea, as the effects of central banking measures start to wane.

The financial world has entered unchartered waters in the past years with high levels of monetary easing skewing markets and volatility alike. More precisely, the ongoing central bank interventions, a significant belief in quantitative easing and a lack of alternatives have significantly influenced asset flows.

More than an estimated 80% of global equity market capitalisation is located in countries in which central banks have kept interest rates at virtually 0% or where they have even slipped into negative territory. A lot of funds have been rotating into equities, driving up indices with only very moderate and shallow pull-backs meaning equity volatility has been reigned in.

Fear-indicators of equity risk such as the VIX, which measures the implied volatility of S&P 500 index options, have been moving through a long trough ever since the last spike in 2011. Back then, a possible Greek default had unleashed a market correction and provoked a sudden spike in volatility. But ever since ECB head Mario Draghi’s infamous promise to “do whatever it takes” to save the euro, things have clearly changed. Due to the lack of alternatives to equities, investors have possibly become somewhat complacent. 

Demand from institutional investors for some form of protection against a possible return of volatility has picked up. ETFs that track the VIX are one of several possibilities. These funds typically move in the opposite direction to the broader market indices and are therefore used primarily by investors who want to capitalise on volatility spikes following sharp market pullbacks.

However, timing is critical, as these instruments lose with every rollover during periods of stable volatility. Volatility ETFs, which invest in volatility futures, are often being seen as a hedge tool when volatility spikes, but the opposite can be true. That is because of ‘contango’, where by contracts further along the futures curve are more expensive than current month contracts. That in turn would not always lead to the desired result, since timing can work against them, which is precisely why some investors are opting for different insurance methods. 

Current low volatility levels offer a cheap opportunity to buy some portfolio insurance by way of purchasing put options. Being a little on the safer side may not be such a bad idea at this point as equity valuations, although not at extremes, have reached a point where any bad news could provoke a small market correction.

Other clients, however, are taking on more risk and are also more willing to sit through short-term turbulences as a trade-off for higher long term performance. We are advising clients to take some risk off the table and to consider alternatives such as real estate, absolute return funds or long/short funds within both equity and fixed income.

That is not to say that volatility may not spike at some point in the future as there are possible triggers such as an unexpected event on the geopolitical landscape or a worsening of the Greek debt situation. How far down the road a serious sell-off may actually lie, obviously remains to be seen – this is why it may not be such a bad time to start thinking about some form of protection against any return of volatility. As always clients should seek advice on the suitability of an investment for their own circumstances where appropriate from a professional advisor.