Strategic thinking breeds success

A colleague recently asked what the real difference between saving and investing is. After an awkward silence, we had to acknowledge that focussing on asset allocation and fund choice has created an advice environment where we tend to forget that the choice of investment vehicle is often just as important as choosing the right asset spread or fund manager.

Choosing funds comes naturally for most experienced financial advisers and may be within their own money anchors. But how often does the adviser stop to consider what the appropriate investment vehicle or outcome will be?

Sing off the same hymn sheet

The client and the adviser must be in agreement on whether a particular investment is aimed at capital growth or income. For many this is an obvious question, yet it is often shocking to see how both the client and the adviser fail to consider this a fundamental issue.

The adviser needs to understand how the client thinks about money and risk. Every person has a very specific relationship with money that has developed throughout their life. It influences their beliefs and attitudes towards money and also how they react towards risk and financial loss.

Money anchors prevent high sea navigation

Money anchors are not greatly influenced by current market circumstances, are subconscious and are difficult to change. In order to understand the investor’s real tolerance for risk, a reliable measuring tool that looks at the South African individual - rather than a general demographic group - should be used.

Once you have established your client’s investment goals and risk tolerance, you have the responsibility of pairing the best possible investment vehicle with the individual client.

The following should be considered when choosing the appropriate investment vehicle:

• Client investment horizon versus investment liquidity: the most obvious example in this regard is the statutory limitations on the liquidity of retirement annuities and endowments.
• Tax implications versus the client’s tax position: the client’s tax position must be considered. Again, using an endowment as example, where a client in the 40% tax bracket is looking to invest in a high interest or rental income portfolio while already earning substantial interest. Such a client may give consideration to investing through an endowment, since the income in the endowment will be taxed at 30%.
• Cost of investing: it should be established to what degree a client is willing to pay for specific features, guarantees, or product options. For example, investing in a collective investment with a single asset manager may be cheaper than investing with a linked investment service provider (LISP). But it does mean that the client will not have access to the range of funds, and possibly the rebates that is available on a LISP.
• Client risk tolerance: Peter Jennings said, “I’ve always shied away from conventional wisdom, although I know the power of it”. The same holds true for investing. Often, conventional wisdom is spot on, but it is just as important to listen to the client and to understand how the client subjectively perceives risk. Many clients suffer from sleepless nights caused by any form of investment risk. The question should be asked: must the product provider carry the risk as is the case with guaranteed income plans or traditional annuities, or is the client prepared to carry the investment risk, as is the case with a living annuity?

Return to the silence

Let us return to our awkward silence. After looking furtively at old varsity textbooks, the answer was easy to remember: saving is about postponing consumption, putting off buying that new car for another year, while investing is about purchasing financial assets with the aim to accumulate wealth over the long term.

In this process, the choice of the appropriate investment vehicle should never be neglected.