Day 7: Final Investment Decision (FID)

 

FID is the final stage of selecting and overseeing a group of investments that meet your long-term financial objectives and risk tolerance. The first step is to formulate your investment goals and constraints. Your goals should be SMART: specific, measurable, achievable, realistic and time-bound. Investment constraints can be of different forms: liquidity needs (how quickly you might need to generate cash), time-bound (need return over a specific time period), tax concerns (capital gains, income tax), personal preferences (ESG rating, etc.) and unique needs arising from your personal situation (e.g. buying a property). The second step is to construct the portfolio by implementing the investment strategy and deciding how to allocate capital across geographies, asset classes (like equity, debt, real estate and gold) and securities (stocks, bonds). The main objective of portfolio construction is to meet investor needs by taking the minimum possible risk. The traditional  approach usually recommends a highly diversified portfolio because it believes that markets are efficient and it is difficult for investors to select "winner" stocks. For example, the historical returns for stocks is between 8% – 10% since 1926, whereas the historical returns for bonds is between 4% – 6% since 1926 [91]. Both asset classes have performed well over time.  Referring to the 70/30 portfolio, it has an average annual return of 9.96% and a standard deviation of 14.05%. This means that the annual return, on average, fluctuated between -4.08% and 24.01%. Assuming a 7.5% return target that consists of a 5.0% required annual distribution, 2.0% long-term inflation target, and a combination of fees and overhead expenses, as well as the desire to at least maintain if not modestly grow the purchasing power of principal over the long term, a 60/40 asset allocation would have struggled to meet this goal during the last 10 years (courtesy of PNC).

According to FinancialSamurai.com, you may select one of the following main types of investment portfolios:

1. An income portfolio that consists mainly of dividend-paying stocks and coupon-yielding bonds (100% bonds, 20% stocks/80% bonds or 30% stocks/70% bonds)

2. A balanced retirement portfolio that invests in both stocks and bonds to reduce potential volatility (40% stocks/60% bonds or 50% stocks/50% bonds).

3. A growth portfolio that consists of mostly stocks expected to appreciate (100% stocks, 80% stocks/20% bonds or 70% stocks/30% bonds).

A (young) investor seeking this portfolio has a high risk tolerance and a long-term time horizon.  Generating current income is not a primary goal.

Here you can learn about the possibilities and risks of all these products. You may choose to invest in various assets: shares, ETFs, structured products (including turbos), hedge funds, options, fixed income securities, warrants, and complex investment funds. Your savings can achieve returns through sustainable investments and have a positive impact on ESG. Generally, investing in shares entails more risk than investing in investment funds or ETFs.

An important part of your strategy is spreading the risk. Spreading ensures fewer peaks and troughs in the total value development of your investments. And the outliers will be less severe, both up and down. Here is how you can spread your investments: you can make use of the entire range (shares, ETFs, equity/bond/mixed funds); you can buy investments from different countries and continents (US, EMEA, etc.), from different business sectors or at different times over one or several years. You can spread the risk of your investment by investing in it for a longer period of time, for instance. The sooner you start investing, the more you can harness the power of compound interest. For example, the return on an investment of $5,000 is 4%. In cash, this is $200.00 after 1 year and $408.00 after 2 years. In the second year, the return therefore increases to $208.00.

You do not have to invest all your money in one go. You can also enter at different times. This is also possible over a number of months or even years. This spreads the risk. You can also choose to set up a periodic investment for this. For example, you can deposit a fixed amount every month.

Costs can have a major impact on your returns. So check in advance whether the costs of a transaction are in proportion to the desired return. Transaction costs also differ for each investment instrument.

Once a portfolio is constructed, it is critical to continuously monitor investor needs and market conditions so that appropriate changes can be made to the policy statement and investment strategy, whenever necessary. It is also important to evaluate portfolio performance on a risk-adjusted basis and compare it with a suitable market benchmark. Investors should remember that this is an eternally ongoing process and they should revisit all the steps at regular intervals (e.g. monthly or bi-monthly).