The Ladder To Creating Wealth

A balance between risk and reward is crucial in devising a health wealth management philosophy

Whether or not you call yourself wealthy, there are several things you can do to achieve your dream and keep it too. An experienced wealth management advisor can play a crucial role. A good advisor assesses your investment objectives, risk profile, age, income streams, current wealth, liabilities, cash flow needs, and so on and, then, apprises you of ways to create further wealth and achieve your financial goals. There are no short-cuts to investing and, more often than not, investors burn their fingers trying to time the market. Following disciplined investing principles with a risk-reward balance gives the best results.

Goals, objectives and constraints

The first step is to identify your investment goals, objectives and constraints. Goals can be tactical/short-term—such as investing to fund the purchase of a home within a year—or strategic/long-term, such as investing to fund retirement. Investment objectives would include such things as investing to grow capital, preserve capital, or create a moderate yield. In addition, you need to take into account the constraints you face in implementing the strategy, such as the funds available, your risk tolerance, and need for liquidity.

Risk-return trade-off

The next step is to focus on the risk-return trade-off. Since your 'real' return (net of taxes and inflation) is the true measure of your wealth gain, you need to track your real investment return. It is also crucial to understand the type of risk you are dealing with. We all know the proverb “Don’t put all your eggs in one basket”. Similarly, investors should diversify investments across asset classes, markets, managers, tenor, and so on, to achieve desired returns with acceptable risks. Diversi­f­i­c­ation involves dividing an investment portfolio among different markets and asset categories, such as equities, fixed income and alternate investments. The process of determining which mix of assets to hold varies from investor to investor and also depends on the investment objectives. If the portfolio has the right allocation, it will be well on its way to delivering the investment goals (with an acceptable amount of risk factored in). Therefore, before making any investments, you should first define an investment philosophy and assess your investment objective, risk profile and suitability (see The Ladder to Creating Wealth).

The asset allocation that works best for you will depend on your time horizon and your ability to tolerate risk. You need to pay attention to structural considerations, such as financial planning, trusts, insurance and annuities, and tax and liability management. Once you have decided on the investment objective and risk profile, asset allocation would include all or most of the following considerations/steps:

• Document all assumptions made;
• Calculate rates of return, standard deviation and correlation between different asset classes;
• Check for consistency of returns across economic cycles and time periods;
• Select the asset mix that would optimise the risk-reward payoff—minimum risk for the desired return;
• Agree on the benchmarks to be used for comparing performance results and degree of tracking versus benchmarks;
• Decide if the investments are to be made on a staggered manner (in 3-4 instalments); recommended in volatile markets;
• Implement the desired asset allocation through best in class products based on net of tax expected returns;
• Evaluate portfolio hedging options and cost;
• Active versus passive management; and
• Periodic review and rebalancing

In its more modern form, asset allocation is a forward-looking exercise, which gives significant importance to qualitative overlay, derived from experts. This makes it a more relevant exercise in today’s time than a traditional quant-based asset allocation. This overlay can be in terms of analysis of geo-political events, macro-economic indictors, market sentiment, or any other factor that cannot be captured by standard risk metrics such as standard deviation of an asset class.

With this evolution tactical asset allocation, comes into play. Tactical asset allocation is not about market-timing, but a dynamic strategy that actively adjusts a portfolio’s asset allocation by taking an informed call on the portfolio in reaction to or in anticipation of the certain trends. While the importance of long-term investments and, therefore, strategic asset allocation can't be undermined, in today’s markets, tactical asset allocation, if followed with rigour, can certainly deliver alpha (incremental returns). Once invested, you should monitor and rebalance as and when necessary. You should have pre-defined profit and loss booking levels based on your risk profile. These levels should be periodically reviewed and reset based on the market outlook. You should also maintain certain liquidity in the portfolio to take advantage of sudden opportunities. In addition, you could consider maintaining separate trading and investment portfolios with different investment objectives.

Investment planning and wealth management are complex undertakings that, while rooted in a foundation of fundamental principles, must be approached differently to address the unique needs and expectations of each individual or family. When managing wealth, several competing goals must be considered. Developing strategies to meet those competing goals require careful thought, and, often, several meetings with your advisor before choosing the one that works best for you. Finally, the most crucial factor of disciplined investing is to never get emotionally attached to your investments. There is no harm in cashing out and staying liquid until the next opportunity knocks on the door.