Investments -- reducing the risks

Investments

Any investor who has invested in the stock market during the past five years has been handsomely rewarded. However, the signs are out there that things are not going to be as easy in future.

There has already been some fallout over the subprime lending issue. This has led to some investors selling in a panic.

During times of market uncertainty many investors often make the cardinal error of panic selling. Their emotions of fear and greed take over.

However, by having a sound financial planning strategy in place, many of the pitfalls of investing can be avoided. Even the most astute investors such as Warren Buffett follow a decision-making framework.

Buffett suggests that “to invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

With the help of a financial planner, astute investors should follow these simple steps.

For most investors, investment markets are quite complicated. However, there are really only four things in which you can invest your money. These are shares, bonds, property and cash.

Sure, you can invest your money in paintings or sculptures but these are speculative assets.

The decision to invest in shares, bonds, property or cash is known as the asset allocation decision. Typically shares generate the best returns over time but are also more volatile than the other asset classes.

The next step is for you to define your objectives. Once again, this is something which should be done with the guidance of your financial planner.

Your financial planner will be responsible for implementing the objectives. The review process, which is done on at least an annual basis, will ensure you remain on track to complete your objectives.

At this point your investment risk profile will be clarified. Various factors must be assessed at this stage, including how long you intend to invest, income requirements in retirement, capital availability and tax.

Most of my clients are retired investors looking to protect their capital from inflation while providing stable income. Retirees, like most investors, should ideally be spreading their investment risk between the various assets classes.

Equities provide the greatest returns but they also carry the greatest risk. Cash and bonds are considered lower-risk investments but at the cost of lower returns.

Taking into account the risk and returns each asset class delivers the investor, along with his or her financial planner, must allocate funds according to his or her needs and cash flow.

Retirees would typically have most of their funds invested conservatively in defensive assets, with most in cash and bonds.

However, few retirees, and certainly only a select few of my clients, can afford the luxury of having all their assets invested in cash and bonds.

Netto-Jonker, CFP, is founder of Netto Financial Services and was financial planner of the year in 2001 .