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Before asking 'What should I invest in?'​ ask 'What, when and how expensive are my goals?'

Updated: May 6

As a Financial Planner, one of the most common questions I get asked is 'What should I invest in?'. However, the answer to this question is the final piece in the puzzle, not the first.

The first step in the Financial Planning process is to uncover your SMART goals. For those that are unfamiliar, the acronym stands for:


  • Specific: A specific goal may be "I want to retire at age 60, and be able to spend $70,000 per annum until life expectancy plus 10 years, and have $500,000 left over for my kids inheritance".

  • Measurable: A measurable goal could be "I currently have $110,000 however I need $200,000 for my home deposit in 3 years which means I need to grow my savings by $30,000 per annum or $2,500 per month for the next 3 years".

  • Attainable: Often people are unclear of whether their goals are actually achievable so it is best to 'dream big' first, and if financially necessary adjust the goal down later.

  • Relevant: What priority is each goal?

  • Time Based: Goals that are too far away can be uninspiring. Goals that are too close can be unrealistic.


Once you have a timeline of SMART Goals, then you can start thinking about how to invest.

It is likely that you have heard of the saying 'High Risk, High Return' or 'Low Risk, Low Return'. That saying could be expanded to 'High Risk, High Return, High Timeframe' or 'Low Risk, Low Return, Low Timeframe'.

To illustrate this point, the following graph shows the Average Investment Return, Yearly Chance of a Negative Return & Worst Yearly Negative Return of 6 different types of investment styles.





Cash has produced the lowest average return of 3.9% per annum whereas a High Growth portfolio has produced the highest rate of return of 7.3% per annum.

So why wouldn't you just put all of your funds in High Growth investments?

A High Growth portfolio has a 29.2% chance of a negative return each year, and it's biggest negative return year has been 31.2%.

Let's assume you have $110,000 saved as per the example above. If you were to invest this all in High Growth, your portfolio could be down as much as 31.2% as you were looking to buy your house. Imagine your $200,000 now being worth only $140,000.

Instead, if you had your funds invested Conservatively, it has averaged a return of 5.9% per annum and only has a 3.3% chance of a negative year and even when it has had a negative year, it has only reduced the portfolio by 2.4%. This means the $200,000 would have only dropped to $195,200.

It is interesting to note that a High Growth portfolio makes a return 1.2x higher than a Conservative portfolio however it has a 9x higher chance of a negative year each year. Whilst this equation appears to suggest that you don't get a great reward for taking on extra risk, there are still many times when Higher Growth portfolios are suitable.

One of the most common examples of when High Growth portfolios work is within superannuation as many people have a sufficient amount of years until they are able to access their superannuation to take on a greater level of risk. In contrast, when people get closer to retirement it is often very important to reduce their risk allocation down so that their portfolio has less negative years, and less significant negative years.

A skilled Financial Planner can help:


  • Quantify your SMART goals

  • Provide guidance as to whether your SMART goals are attainable

  • Build the right portfolios to match the right goals and objectives

DISCLAIMER:

The above table shows the actual historical annual returns on Mercer’s five Model Risk Portfolios (Cash Portfolio excluded) from 31/03/2001 to 31/03/2021. The returns are calculated using the current Mercer’s Strategic Asset Allocation (SAA). These figures are historical only and cannot be relied upon in the future. It is also important to note that while time frame is one factor in selecting your asset allocation, it is not the only factor and should be considered along side other factors of your risk tolerance.

Any advice in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters


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