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Building an Investment Plan


There are a number of key factors that must be assessed when putting together a suitable investment plan. Each of these factors will need to adequately match your own personal needs and objectives. Below I have identified the main criteria that should form the fundamental building blocks of any investment plan.

 

Time frame. The time frame of an investment refers to the length of time that you will need to tie up your money before the investment matures or provides the desired return.  

Liquidity.  Liquidity involves the ease in which you can access your money. Typically this would be measured as the time it takes to get the physical cash back in your possession.   

Risk Profile. The risk profile of an investment refers to how volatile the investment can be. This is typically measured by standard deviation and will measure the potential for upward and downward movements.  Your own risk profile relates to how comfortable you are with the potential for upward and downward movement in value of your investment.

Diversity. Diversification of investment involves having a range of different asset classes in your portfolio in order to spread your risk. The idea of having a diversified portfolio is to smooth the investment journey by not having all your investments exposed to one asset class.

 

 

Time Frame:

Time frame and liquidity can be considered to go hand in hand.  As mentioned above liquidity can be described as the time it takes to get your hands on the physical cash. The liquidity of an investment will very much depend on the time frame and type of investment that your money is in at the time. Therefore, through managing the time frame of your investment you should be able to manage your liquidity needs.

In general, it can be said that the longer you invest your money for, the higher the potential returns can be. This is due to the fact that if you invest over the long term, you can typically ride out market cycles both good and bad and effectively create a long term average return.  This principle is generally quite correct however it is important to manage and monitor the investment throughout the course of the term. This is particularly relevant coming towards the time when you need to access the money again as you do not want to be exposed to a possible market downturn coming up to the maturity date. This can have the effect of eroding possible gains that were previously made. The other advantage of long term investing is that you can take advantage of the effects of compound interest. If we look at some simple calculations we will be able to see clearly the power that compound interest can have over the long term.

If we take €100 invested for 100 years at a simple interest rate of 6% per annum, the total value after 100 years would be €700.

If we take the same €100 invested for 100 years with compound interest of 6% per annum the value after 100 years would be €33,930.

You can see that the effects of compound interest are astonishing and this is why many people refer to compound interest as the 8th Wonder of the World. It also shows the potential benefits that come with long term investment.

What are the key questions that you must ask yourself when looking at time frame?

The first question is you must ask yourself is; When will I need to access this money again in the future?

If you need to access your money in the short term, there is no point in having a long-term strategy for investment. You need to plan around your short-term needs and come up with a strategy around that.  Where your investment time frame is short term in nature, you will be limited in your investment options however that does not mean that you should take any less care in trying to maximise your returns.

Have you made provision for any Known short or medium term need?

If you know there’s a future event that you’ll need access to cash, again you should manage your investment time frame around that. It is vital that your money is not locked away in an investment when the cash is needed to cover an upcoming cost. Having to break an investment can result in losses or penalties that could see you end up in a worse position than you may currently be in.

 

 

 

Have you planned for any unforeseen event?

In all our lives, there are unforeseen events and emergencies where we’ll need to access our cash on short notice. It’s important that, as part of any investment plan, that this is covered, and a plan made around this. This would typically be described as your emergency fund. All investment plans should take into account the possibility of an unforeseen event occurring in the short to medium term and therefore provision should be made for this.

How to Manage your Investment Time Frame

When looking at your own investment time frame you will need to identify your own short, medium and long-term needs. Once this is done you can then set about building a plan around these and maximising the growth potential for each part of your investment.

What are these needs?

Short term:

The short term needs will primarily be your day-to-day needs. These needs can be described as your living expenses such as food, light, heat and other essentials that you will need to pay for on a regular basis. These day-to-day needs are typically covered by your income. These funds are will not form part of the investment strategy although as already mentioned in previous chapters, careful management of your income can built funds for future investment.

 

 

 

 

 

Short/Medium Term:

In the short to medium term you will have known expenses that you will have to cover. Examples of these may be childrens education or replacing your car. You will also have unknown expenses that may occur on an ad-hoc basis and will also need to be provided for. To cover these needs funds would typically invested in cash deposit accounts at your bank at no more than a nine-month deposit period. Given the fact that these expenses can arise at any stage a good solution may be to have a range of short term deposit accounts with varying accessibility from one to nine months.

Long Term:

Long Term needs can really be classed as the true wealth creation needs. Your long term needs would typically consist of the need for financial stability and wealth in later life.

It is within the medium and long term investments that you will hopefully achieve the potentially higher growth rates while also taking advantage of the effects of compound interest.

Given the number of varying time frame restrictions it is important that you manage all of these so that you are not only providing liquidity at the right time but also maximising growth potential at every opportunity.

The management of this can be achieved as part of a structured plan through the use of what we call “rolling maturities.”

What exactly does “rolling maturity” mean?

Quite simply rolling maturities means putting together an investment plan that will have regular and frequent maturity dates within the overall investment plan.

This means that where you have a set amount of money to invest; it is not all put in to one investment with one future maturity date.

Rolling maturities is about using multiple different investments with multiple different maturity dates.

This will mean that throughout the investment period there will regularly be money maturing. This then allows you to reassess your needs at each interval.  This is important as your needs and objectives will most likely change regularly also and the regular maturities will allow you to move your investment plan in line with any changes.

What are the results of setting up a rolling maturity investment plan?

Rolling Maturities allows you the ability to manage change across a number of different headings. These changes may be changes in your own circumstances such as the birth of a new child or change in career. They may be changes in the economy and the global markets in general. We have seen how this can change quite dramatically following the 2008 crash.  

 

 

The fact remains that we don’t know what is going to happen in the future so your investment needs to be adaptable to any changes that may occur. Regular re-assessments and maturities allow you to adapt your investment strategy around these possible changes as they occur.

The key to managing time frame is planning. It’s complex. There are a very huge amount of different investment possibilities with different maturity dates available to you. This involves sitting down with your financial advisor to put a plan in place, to assess your goals and come up with a strategy around them.

 

Asset Classes:

When you reviewed your time frame for investment and you know how long you can invest each portion of your investment we can then look at the typical asset classes that are available for investment in. The following asset classes are the primary asset classes and there is an exhaustive list of variations available on each. So, for the purposes of this guide I have limited this to five main asset classes.

 

Cash:

Cash is the first asset class that we can identify in our analysis. This is typically a low risk asset class and so, in general, the funds invested in cash will not see a fall in value through the investment period.

In exchange for this security however you should only expect to receive very low rates of return on your investment. 

Given the low rate of return, quite often you will find that the rate of inflation may be running higher than the cash deposit rate. In this situation while the value of the cash may not fall, the true value of the money or purchasing power will decrease and so provide negative real returns.

The advantage to cash investment is that it tends to be the most liquid form of investment and therefore it is easily accessible. Typically cash investing would be used to provide for your emergency funds and your day-to-day funds.

Cash investment is predominantly carried out through Banks using deposit and current accounts.

 

Bonds

The next asset class in our analysis is bonds. Bonds are typically considered low to medium risk depending on the type of bond that you invest in. However, there are also high risk bonds available and so careful analysis of the type of bond you are investing in should be carried out.

 

What are bonds?

Bonds can be described as loans given to a Corporate or Government body for a set period of time after which the principle amount is paid back in full. The issuer of the bond may undertake to pay a rate of interest on the principle amount. This is can often be known as the coupon rate. Obviously the higher the coupon rate, the higher the returns will be on your investment.

However, you should be wary of bonds offering very high coupon rates as the higher the risk of the bond issuer defaulting on the repayment of the principle will be. 

Bonds can be described as relatively liquid because you can buy and sell them on the open market. However, depending on the time of the sale, it is possible to lose money in selling the bonds.

Given the relatively low nature of most bonds the returns are likely to be modest at best and therefore you are not likely to see the huge returns on your investment.

On the flip side of this you are unlikely to see massive negative returns on this kind of investment particularly if held until the maturity of the bond.

As mentioned bonds can be volatile depending on the bond that you invest in and therefore there is need for careful management when investing in this asset class. Bonds can however form an important part of any investment strategy.