We hope you find this archived article enlightening. Please remember that investment, pension, and tax rules frequently change, so some of the content may be outdated. Nevertheless, we aim to provide valuable insights.
“I’m getting old, and I need something to rely on.”
These lyrics from the beloved Keane song “Somewhere Only We Know” (2004) resonate with many modern investors. Regardless of your taste in music, the sentiment rings true: what can investors depend on to secure their financial future?
Here are four straightforward rules that investors of any age or background can trust.
1. Inflation is Not Your Ally
Most of us have a complicated relationship with inflation. We receive periodic updates on inflation rates and understand its impact on our purchasing power. When interest rates rise alongside inflation, it can strain our finances with higher mortgage and loan payments.
However, the long-term effects of inflation on our wealth are often underestimated. If your investments do not outpace inflation over the long run, you risk diminishing your purchasing power. Holding large cash reserves over time is typically unwise unless you require liquidity for specific reasons.
For instance, consider a scenario where you withdraw a 5% annuity yield from a £500,000 pension portfolio with no additional contributions. This would yield £25,000 annually. If left untouched for 20 years at a negative real interest rate of -2% (the average over the past decade), that pension pot would shrink to £333,804 in today’s value. The resulting annuity would drop to £16,690, representing a 33% loss in real purchasing power. Clearly, inflation is not a friend to cash holdings.
2. Volatility Can Be Beneficial
While it can be unsettling to see your investments drop in value, the essence of diversified investing is to spread capital across different markets and geographies to achieve attractive returns. The principle is simple: without risk, there are no returns. If you are willing to embrace higher short-term volatility, you can expect to receive greater rewards in the long run.
However, keep these three points in mind:
- Market volatility produces both gains and losses. With volatility comes risk.
- Past performance does not guarantee future results; last year’s returns may not repeat this year.
For example, a simulated return chart for Nutmeg’s Fixed Allocation Portfolio C demonstrates substantial annual variability in returns.
Time diversification is key; the longer you invest, the more you may benefit from enduring short-term fluctuations. Historical data shows that investments in volatile assets, like those in the Nasdaq US technology index, often lead to substantial returns over time.
3. Asset Diversification is Key
Maintaining a well-rounded mix of income-generating and growth-oriented assets across various geographies can mitigate risks while enhancing the potential for better returns.
Simulated long-term returns for equity and bond portfolios similar to those in Nutmeg’s Fixed Allocation range show that as you increase your risk (moving from Portfolio C to D), long-term returns tend to rise. This observation suggests that effective asset diversification can bolster confidence in the higher risk, higher return adage.
Moreover, diversified portfolios have shown shorter recovery times after declines compared to concentrated investments. For example, during the COVID-19 market panic, the FTSE 100 took 18 months to recover, while a diversified portfolio rebounded within six months. Patience goes hand in hand with effective diversification.
4. Active Management Can Help
Markets often exhibit idiosyncratic risks that can significantly impact individual assets. Engaging a professional investment manager to consider these factors during portfolio construction can enhance the risk-return profile. While Nutmeg’s Fixed Allocation portfolios are constructed based on historical data, active management allows for responsiveness to structural shifts (like Brexit or geopolitical changes).
In conclusion, here are the four principles to rely on when investing:
- Beware of Inflation: It erodes wealth unless you’re achieving a return above inflation. Large cash holdings are rarely wise over extended periods unless necessary for liquidity.
- Embrace Volatility: A globally diversified portfolio can help manage the inherent risks while potentially yielding higher long-term gains.
- Diversify Assets: Combining various income and growth assets across regions can improve risk-return dynamics and generally lead to quicker recovery times after value reductions.
- Utilize Active Management: It helps navigate individual asset risks and provides assurance during market fluctuations. Many investors value the peace of mind that comes from having professionals dedicated to managing risks associated with their portfolios.
Lastly, remember to be patient. Well-diversified multi-asset portfolios tend to recover more swiftly than individual asset classes after downturns. Patients who hold on during dips often see their investments rebound more quickly than the periods of decline.
Risk Warning
As with all investments, your capital is at risk. The value of your portfolio with Nutmeg can go up or down, and you may receive less than your initial investment. Past and projected performance is not a reliable indicator of future results.
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