Do you know what are the odds of you getting a positive return when you are invested in any 1-year, 5-year, 10-year and 20-year period? In this episode, I will walk you through a few scenarios to help you better understand the type of investment portfolios you should be investing in such that the odds are in your favour.
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Hello and welcome to another episode of Expat Wealth Blueprint show.
Today, we’re going to be talking about time scales and how to think about how you should be investing given different goals. And sometimes this is called the bucket approach, sometimes this is called the liabilities managing approach. But it’s definitely something you want to try and get to grips with, especially if you’re going to be a DIY investor or you’re going to go and reach out to different financial providers and buy different products. You really need to have a handle on what you’re using that product for and how it fits into your plan.
So why is this so important?
Today’s regulators, no matter where you go, tend to want every product that’s purchased to be accompanied with a risk profile questionnaire. And what that looks like is something like, “If the market was to drop, what would you do?” And if you say, “Oh my God, I would freak out”,then you’re probably going to get put into a low-risk product. And if you say, “Fantastic, I’m going to buy more”, you are probably going to be put into a high-risk product. And the regulator basically pushes you that you’re never going to get into trouble if you put someone in a product that aligns with their risk profile.
But I think that’s a little bit simplistic. And how we think about it at Providend and Chris Tan, the Founder of Providend, talks about this a lot is, that’s just looking at your willingness to take risks. And it’s quite abstract to say, “Okay, this is your willingness to take risks”. It doesn’t look at what’s your need for risks. And therefore, maybe you should be nudged up or down that risk profile. And so, this is where this time scale or goal-orientated way of thinking about your money really comes in.
Now I’ve been lucky enough to speak to a few advisers that look after people with USD $15 million, up to USD $200, $300 million and this is exactly the approach they take. So, I haven’t got any clients with USD $100 million. But this is definitely a process that we use at Providend and definitely something I use for my own money. So, it might be useful for you.
Now obviously a caveat here is, don’t necessarily take this as financial advice. I’m not trying to nudge you in a certain direction around risk, it’s just more a concept to make you think about how you might have gone about investing.
What’s this all about?
Simplistically, the longer you’ve got in the stock market, the higher your chances of getting a high return. The shorter timeline you’ve got in the stock market, then the less certain it is, whether you’re going to be positive or negative. So roughly, if you’ve got 10 years’ timeline stock market, you should always be positive. If you’ve only got 1 year in the stock market, it’s going to be a lot shorter. And therefore, you don’t want to be fully invested in the stock market if you’ve got short time periods.
How I suggest you think about this is, think about all of the life and financial goals you want to achieve and then put some timelines around it. And then that’s a way of trying to work out how much risk you might need to take to achieve those goals. Bear in mind, you still need to do that risk profile bit about your willingness.
Before I look at some examples, let’s just look at some of the data The team at Providend, so Kyith in particular– So Kyith got a great blog that’s worth checking out which is Investment Moats. He has been writing in that for years. I want to say 10 years. Got a massive following. So, he took the MSCI World Index. The MSCI World Index is a global stock market tracker benchmark. So, it takes all the different companies and all the different stock markets around the world, and for a lot of funds, that becomes the benchmark. And when we talk about the market, the stock market, often we’re talking about something like the MSCI World Index.
We took the data from 1970 up to the end of 2020. And what Kyith did is, he moved that data forward, one month at a time. So, we would take January 1970 to December 1970 and look at what the return was. And then, he took the return from Feb 1970 to January 1971 etc. Over that 51-year period, there are 603 individual 12-month periods we can look at. And what that showed is, over the last 51 years, if you took any one of those 12-month periods and you only had one year in the stock market, you were positive 76% of the time. 22% of the time you were negative.
So, imagine you’ve got a short goal, you just want to park some cash in the market for 12 months and you want to put in 100% equities. Historically, you’ve had a 1 in 5 chance that your money would have dropped in value. Now you could look at it and say you’ve got 76% that is going to be up, but putting the financial planning hat on, you always want to be more conservative. That 22% negative, of those, 11% of the time you were 0% to 10%, 7% of the time you were –10% to –20%. And then you’ve got a few bits. So, 7% chance that you could be down 10% to 20%
If that was a house deposit, for example. Let’s say you’ve got some cash, you’re going to buy a house in 12 months. Being down 10 to 20% is going to massively impact what deposit you can then put down on that house. If we go out and look at every 5-year period over those 51 years, then your odds of being positive go up. So, 88% of the time, after 5 years, you were up. Historically, you would have been down 12% of the time after 5 years. So, imagine you’ve invested your money and you’re down 12%. Now what we see here is, the amount you’re down tends to be a lot less. So pretty much all of that 12% is in the 0% to –5%. You’d only be down slightly. But you still could be down
If we look at every 10-year period, then actually there was only 3% chance. that there was a rolling 10-year period in the last 51 years that you’d actually be down and you’re down between 0% and 2.5%. And if we look at every 20-year period in the last 51 years, there’s not been one 20-year period where you would have actually been negative. This is why we say the longer you’ve got in the stock market, the higher your chances of being positive are. That’s where that’s coming from. It’s important that you understand this. Let’s think about how we could use this.
So, if you’ve got a goal that is in the next 1 to 5 years, we know historically, the odds are that you could be negative about 10% to 20% of the time. So that’s where you might want to go with a lower risk portfolio with higher certainty of what you’re going to get. Whereas if your goal is 10 years or longer. Let’s say your goal was 20 years’ time, you want to retire in 20 years,you’ve never been negative in the stock market. And therefore, why would you want to go really conservative if your timeline is 20 years?
So, let’s say you’re putting some money aside. Let’s say you’ve just had a baby and you like the idea of putting some money aside for them. And you’re going to give it to them on their 25th birthday. You’ve got 25 years. Now, you might be a very risk adverse person and so this is why it’s not necessarily investment advice. And you might want to go on a very conservative portfolio. But one thing that I would say you should consider is, if you put that in 100% equities and you’ve got a 25-year timeline, actually, your risk of being negative is very, very low. The thing you’ve got to overcome is more that you’re going to see the markets go up and down.
And so can you emotionally take it?
Again, this is something that Chris talks a lot about. The head knows that you should be in 100% equities, but the heart can’t take it. So, we definitely got to factor those in. But if you’ve got a very long time horizon and you don’t need the money and it’s something discretionary, like giving money to your children, then I would argue you could definitely go up the risk scale. But if you came to me, and you are the highest risk person I’ve ever seen. Want to take risk all the time. And you want to buy a house in 12 months, and you’ve saved the money. I would be nudging you really down the low-risk end. Even though you only might make 1%, 1.5%, 2% over that period. We’re going to put you in something that looks much more like bonds, and we’re not going to take very much equity risk at all.
So, this is why it’s key for you to go and document what your life goals are, what your financial goals are, what the timelines are for each of those. And then you could just start assigning what would be a realistic portfolio. So, you can see now why at the start, I said if you’re a DIY investor and you go and meet different financial providers and every time you do a risk profile questionnaire and you come out moderate risk, all of your money is going to be a moderate risk portfolio. And that might not make sense because some of the money might be conservative low timelines, some might be for your longer timelines. And you don’t want to be in a moderate portfolio for 20, 25 years, 30 years, 40 years.
If the provider that you’re working with doesn’t understand this concept, and for a good reason they might be wanting to be on the very cautious end of, “I’ve got a risk profile questionnaire, and this is what it supports”, you definitely need to understand it yourself that, “Okay, I know that my willingness to take risk is moderate. But I understand there might be circumstances where I should be willing to take slightly more risks knowing that it’s all about, ideally want to look at what the historical returns have been to give you a feel for how much risk am I taking”.
Let’s be clear when we’re talking about risk, we’re saying the higher the return, the greater the risk. Greater the risk means less certainty. So of course, you get higher returns if you’re prepared to have a bit less certainty. Hence why, if you’ve got 5 years in the stock market, that can be quite risky.
If you’ve got 20 years in the stock market, there’s a lot more certainty around what your long-term return expectation should be. Obviously, we don’t know what the future returns are going to be, but it gives me some comfort, at least when I’m investing my own money to look at things like 51 years of data to give me an idea of what kind of returns I can expect to get.
Short episode today, but I hope you find that useful. Like I said, go and document it yourself. Reach out to me if you want a bit more information on the MSCI World Index. Or if you’ve got some spare time in the week or the weekend, go and pull up any kind of charting software and have a look at the MSCI World Index. Pick your own periods. Get a feel for what returns could have been. But more importantly than that, like I say, go and think about your own timelines. Think about kids’ education goals, buying a house, long-term retirement money, inheritance money. Put some rough timelines around it and go and have a look at how you are investing at the moment and think about whether you need to tweak that up or down accordingly.
As ever, leave me any comments either on YouTube or email me at [email protected] and let me know any feedback or anything you would like me to cover in the future.