Morningstar Investment Management's Chris Galloway shares some important insights.
Capital preservation is key to building wealth.
Understanding capital preservation is about understanding the risk. "Risk is the permanent loss of capital in real terms over the investor's time horizon," he says. In actual numbers, Galloway stated that investors would have to delay their retirement by 6.3 years to recover from a 25% capital loss in their portfolio.
Avoiding large losses remains a key element to building wealth. In other words, capital preservation is the key to building wealth.
Permanent losses are driven by valuation (overpaying for an asset) and fundamentals (deterioration in asset quality or cash flow). The key to managing valuation and fundamental risk is to avoid overvalued assets and diversify across investments whose cash flows are driven by different factors.
Valuation risk is one of the biggest risks that investors face.
The key thing with valuation risk, and absolutely it is the key investment risk faced by investors, is the risk that you overpay for an asset. So for every asset you are able to fix a valuation for it.
There are times when valuations are cheap, or prices are cheap, I should rather say, relative to the underlying value of the company. That's a great time to be buying. There are times when prices get very, very expensive. The key thing for investors is recognizing periods where assets are rather over or undervalued and seeking opportunistically to take advantage of those.
Right now, we see valuations as reasonably stretched for several markets around the world and so it is a time in which investors will be well served just to be patient.
It is worthwhile considering annuities.
In the context of annuities in terms of retirement is the issue of longevity or basically outliving your retirement savings. Where annuities actually have a role to play is, obviously, in providing some form of guaranteed income. So, for an investor who incorporates an annuity in their portfolio, it basically gives you some portion of your portfolio that has a stable income and it enables you to be more aggressive with the other part of your portfolio.
Not for everybody, but certainly something worthwhile considering in the context of an investment portfolio, particularly for retirees.
The above insights were shared at 2014’s and 2015’s Morningstar SMSF Strategy Day held in Australia, which brings together leading investment experts and commentators to present insights designed to empower SMSF trustees make informed and confident investment decisions.
A SMSF is a self-managed superannuation fund -- a trust structure that can be used to manage retirement savings on behalf of its members.
