Amid heated debate among analysts regarding the future direction of interest rates, investors should not be tempted to rush into adjusting their portfolio and investments, as this could have unintended negative effects on their long-term savings goals.
While there might be a relatively small number of individuals who will have to make adjustments to their portfolios in light of their personal circumstances, investors should nevertheless be wary of the potential unintended consequences of their actions. This is because selling riskier assets to buy low risk assets might subsequently result in the investor not being able to outperform inflation over the long-term; however, their portfolio’s growth characteristics might become more stable.
As long as investors perform a rigorous and structured process initially to select their asset allocation mix — based on objectives and timeframes — they should not adjust their portfolio in light of recent interest rate scares.
Adopt a rational approach
The impact of interest rate increases on asset pricing is largely determined by the expectations of market participants. During ‘normal’ market conditions, the effects are usually an increase in demand for short-dated, money market-type instruments, as these instruments will yield more if the interest rate increases. However, for other asset classes such as equities, property, offshore and bonds, there are a number of other factors which play a role in current pricing and subsequent returns.
Unfortunately, because investors are often ill-informed of these potential effects, they feel more secure making adjustments to their portfolio. However, short-term changes such as this can affect the long-term balance of the portfolio when the market readjusts.
It is therefore crucial to ensure that the assets in a portfolio complement each other and enable the portfolio to perform fairly well in all market scenarios. This involves developing a thorough understanding of the assets that are being included in the portfolio, along with understanding the way they react to various macro-economic outcomes. This will ensure that you aren’t completely surprised when an outcome adverse to your expectations occurs.
Investors should take the following steps in order to ensure that they adopt a rational approach to investing:
1. Obtain a thorough understanding of your future goals and objectives.
- Usually the best idea is to make a list so you can prioritise.
- Think carefully about what you really want and if it’s realistic.
- Accept that you can’t have/do everything.
2. Evaluate your current life situation with respect to wealth, spending habits, debt, family commitments.
- Consider each topic both on its own and in the bigger picture.
- Are your commitments greater than you can manage?
- Will you have money left over for the luxuries?
- Don’t make the mistake of spending on luxuries first!
3. Carefully consider your ability to continue earning a stable income (if you are not already retired).
- Be aware that you can go out of business.
- Is your income highly variable – dependant on the business cycle for example.
- If your earnings are not stable, are your expenses sufficiently low as a proportion of your income, ie do you have enough of a buffer to withstand the tough times? One of the worst things that can happen is for you to redeem a large chunk from your investments out of desperation when markets are at low levels.
4. Objectively assess your relative skill, experience and success rate in making investment decisions.
- People tend to be biased in thinking that their abilities are better than they actually are.
- Think about whether you really have skill in making investment decisions or are your abilities due to a combination of luck and selective memory?
- Believe it or not, the ability to succeed in business doesn’t automatically mean that you will succeed in financial markets — although it does help somewhat.
- Consult with a professional financial advisor. Spend as much time as you can afford in getting the right person to assist you — this will make all the difference.
- Be aware that even the best financial advisor can’t time the markets — so there will always be times when other funds are doing better than your investments when measured over certain periods. The trick is not to panic — this is inevitable! Rather focus on your long-term goals and objectives and whether you are putting aside enough money each month to be able to meet them.
A professional financial advisor will be able to carefully consider all of the above points and more — and will structure a solution for your individualised needs.