In the last blog entry we looked at the specifics of how you might implement the Plain English Finance “keeping things simple” strategy.

It is my belief that the investment method we outlined is a great approach if you would rather not spend a significant amount more time learning about money and finance.  It will ensure you pay low fees, end up with an excellent spread of assets and have a high chance of making consistent returns.  This can yield wonderful results in the long run thanks to the power of compounding.  I would hope that those of you who have read this far have found the arguments logical, backed by evidence and compelling as a result.

Whilst I believe that the strategy suggested is an excellent solution for anyone who doesn’t want to spend too much time on their finances, at the end of that piece I noted how there really is no substitute for “taking things further” and learning more about all things financial.  We will start this journey here…

Given how dynamic the financial world is today and given how big a subject investment is,  I believe it is worth taking a more proactive approach to looking after your money, particularly if you have a reasonable sum to invest.  Learning more about finance and investment will mean that you raise your chances of growing your money more quickly whilst simultaneously increasing your confidence that you can do so as safely as possible.

Given what a huge subject finance is and how it is constantly changing, the information in the last chapter of my book which is replicated in the next few blog entries, is absolutely not intended to be a comprehensive guide to everything you need to know in order to become a successful investor.  That information would run to thousands of pages and would need updating weekly, possibly even daily.

What I do hope to achieve in these next few “taking things further” blogs is:

1)    …highlight some of the key concepts you will want to understand to get up to speed on finance…

2)    …point you in the direction of some good quality resources which will help you get to grips with these concepts…

3)    …give you some examples of what can be achieved if you do…

If you read chapter 12 of “Own The World” or take the time to navigate through the next few blog entries, you should be able to start on the road to knowing how to do three important things:

1)        Make decisions about asset allocation

Throughout my book and various blog entries, we have established how important it is to invest in a wide variety of assets.  We then looked at a largely formulaic way of achieving this using the “keeping it simple” approach.  If, however, you are prepared to get to grips with various basic aspects of finance, you will get to the stage where you can finesse your asset allocation to take advantage of phases where one asset is performing more strongly than the others.

Armed with a reasonably in-depth knowledge of basic financial analysis, economics and economic history, you are capable of making big picture decisions about when certain assets are more likely to perform better than others.  As an example, anyone with a good grasp of relative value between the various asset classes might have decided to be heavily weighted towards the precious metals from 1971 until about 1980, towards equities from the early 1980s until about 2000 and then back to precious metals at that point until today.  This approach would have resulted in very high returns indeed for no less than forty years.

Many people will read the above and argue that making these calls successfully is impossible.  This is certainly a fashionable view in the finance industry.  That is to say that “hindsight is 20:20” but it is unrealistic to think that anyone can time markets as successfully as in my example above.

I politely disagree.  As I have said several times before, you will never be able to make these sorts of calls with perfect timing but without question there are ways of comparing the main asset classes to each other which highlight times when one or other of them is more likely to be good value.  We have already seen some of these methods in previous blog entries, for example in the section on gold when we compared the gold price to the oil price and the level of the stock market.  I would repeat that one of the reasons relatively few people succeed in making these big picture asset allocation decisions is quite simply that relatively few people take the time to understand and look at all asset classes or even work out how to invest in them.  This is true for private and many professional investors.

That said, there are plenty of examples of professional investors who have made these calls over the years.[1]  Increasingly you are able to learn who these people are and follow their advice, often entirely free of charge.

Optimal asset allocation also changes with your age

The other thing to bear in mind here is that one of the universal rules of sensible investment is that you should become more conservative with your investments the closer you get to retirement.  When you are young, you can afford to a bit racier in a bid to grow your money as much as possible.  At the most basic level, this implies owning more shares and less bonds, all other things being equal.  As you get older, however, you should be thinking more about the return of  your money than the return on your money.

There would be nothing more tragic than having a nasty negative year in your late fifties, for example and giving up a large amount of the pot you have worked so hard to build.  Having a down year in your twenties or thirties will mean you lose less money in total (given your pot is smaller at that point) and have more time to make it back.  Generally this means that as you approach retirement you ensure that you keep more of your money in bonds and cash and less in shares.

As you gain a deeper understanding of these things, you will be able to make your own decisions about how to allocate your money to shares, bonds, commodities, cash and real estate as you get older.  This is not easy by any means but the more you learn, the better chance you will have of getting it broadly right over the years and this will have a very positive impact on your ability to make great returns whilst minimising your risk.

(2)  Start thinking about investing in individual assets

Once you have learned a bit more about finance you might also consider investing in individual assets yourself (rather than just funds as discussed in the last chapter).  For example, armed with the knowledge that follows, you might soon feel confident enough to choose an individual share or commodity that you think has a particularly bright future.

I have owned a fair few things over the years which have gone up 100% or more.  Last year I sold a commodity which made me over 160% profit in just over eight months and a share that was up 350% in about 18 months.  Obviously, these sorts of gains don’t happen all the time and there are always losers to contend with but, as you can imagine, you don’t need too many successes like these to have a significant positive impact on growing your pot until it can fund your target lifestyle.

You are unlikely to experience these sorts of returns owning a basket of funds as suggested in the “keeping it simple” section.  Finding and investing in big winners and avoiding losers requires more knowledge but it really isn’t that difficult to get a point where you can start to have a go at this if you are prepared to learn a little and ensure you are using the right resources.

(3)  Start thinking about learning how to “trade”

Once you have had a look at the material that follows, you will be more likely to start “trading”.  That is to say, you will consider making more regular purchases and sales of financial assets and holding them for a shorter period of time than if you were following the method I suggest in the previous chapter.  If you manage to do this successfully it can have a significant positive impact on your returns as we shall see.

If you can use certain techniques to improve your chances of buying the right assets at the right time and to buy low and sell high, you stand to make significant returns.  This isn’t easy but there are methods of investing which achieve consistent returns, particularly if you understand certain valuation metrics and are willing to think globally and about a diverse range of assets.

One thing worth bearing in mind when thinking about becoming more of a “trader” rather than an “investor” is that, in my opinion, you should only use part of your capital to do so.  This is related to the point about asset allocation above.  Even if you have a reasonable amount of money to look after and feel confident that you have learnt a good deal about exciting trading strategies, I would suggest you continue to keep a large portion of it in more conservative, longer term investments.  Another tragic scenario in investment, which too many people fall foul of, is to decide to use more aggressive and short term trading strategies that you are excited about with all of your investment capital.

It is perhaps helpful to think of “trading capital” as another one of the fundamental components of your asset allocation strategy.  That is to say that even if you think you’ve become quite good at short term trading you might allocate your money something like:

40% longer term investments in shares and share funds.

25% in precious metals and other commodities.

10% in bonds.

10% in real estate funds.

15% to “wing around” trading more risky assets (perhaps foreign exchange or very small, higher risk shares for example).

To continue the example:  As a UK resident you can use a spread betting account to have lots of fun with trading.  You might, therefore, allocate the “wing around” 15% of your capital to a spread betting account.  A small minority of people who become good at this after putting in the work can make extraordinary returns with spread betting.  My point is that, arguably, even those people should still only use about 15% of their overall pot for that purpose.  Any profits they make might then be used to buy more of the other four asset classes.  This is far safer than using 100% of your capital to spread bet.

A Final Point on “Taking Things Further”

Before we move on, I want to make a key point about what follows:  There is a chance that as you read it for the first time, much of the information and terminology will seem alien and quite possibly rather daunting and complicated as a result.  To a great extent the ideas in this chapter are rather complicated.  Getting up to speed on finance in any detail is no walk in the park.  I stand by the statement I have made in my book and in earlier blog entries, that you would be able to make a great positive difference to your finances in less than the time it took you to learn how to drive because I believe reading chapters one to eleven of my book and setting your affairs up as recommend in “keeping it simple” qualifies as taking less time than learning to drive.

The journey to true financial literacy advocated here, however, is a longer road to travel but one I hope you are prepared to at least consider.  You may find some of the sections to be rather complicated to begin with but I would hope that if you are willing to persevere and, most particularly, to start to immerse yourself in the resources suggested, you will find you start to get these concepts reasonably soon.  I repeat that the benefits of doing so are life changing.

So now let us turn our attention to the basic ideas and resources which will help you to achieve the three goals above…