Spanish savers have always been characterized by their conservatism, which has led them to overweight fixed income in their investment portfolios. The spectacular performance of the Spanish stock market during the late 90s prompted a redistribution of the average saver's wealth, but, as has been seen in the last two years, this shift occurred without adequate planning; that is, without taking into account, in many cases, factors such as the time horizon, taxation, risk, or the investment objectives themselves.
Today it is necessary to distinguish between those financial entities (Banks, Savings Banks or Securities and Stock Exchange Companies) that are able to offer their clients a true financial planning of their investments, taking into account, on the one hand, a whole series of factors specific to each investor, such as their time horizon, their risk aversion or their tax situation and, on the other hand, a series of general factors such as inflation, the situation of the markets or the correct allocation and diversification among assets.
The rapid development of financial markets in the last decade thanks to new technologies, as well as the existence of brand new instruments (Unit Linked, SIMCAVs, …) and financial assets (warrants, EFTs, …) offer the investor a puzzle whose pieces are difficult to fit together alone.
In this sense, it's important to distinguish between financial planning and investment, and pure speculation. The latter involves trying to profit from the stock market's volatility, selling at the peaks and buying at the troughs. Speculation can also involve trying to identify the next Microsoft—the company that will revolutionize the markets with an innovative product—or investing in companies in precarious situations (or even insolvent, like Puleva in 1995) in the hope that this will be the turning point from which they begin to turn a profit. Not to mention trying to capitalize on the cyclical reversal of investments in cyclical companies (Ence, Acerinox). These types of operations, on the one hand, carry an extraordinary level of risk and, on the other hand, require a high degree of expertise and are beyond the reach of the doctor, plumber, or architect who simply aims to optimize their savings without trying to "live off the stock market."
Financial planning, on the other hand, is based on the existence of a financial surplus, that is, a capacity to save, and is defined as the management of that surplus over the entire period established by the client. Ultimately, it involves exchanging a certain and immediate satisfaction (current consumption) for a deferred and uncertain one.
The planning
financial step by step
In the same way that there will be a suitable car for each type of driver (a sports car for a young person, an SUV for a mountain lover, a passenger car for a family man or a van for a delivery driver) there will be a specific investment for each type of investor.
Thus, the question that many people ask when they go to an advisor for help in carrying out a financial plan, "what can I invest in?", should be transformed into "what do I want to invest in?".
That, then, would be the first step in defining a financial plan: clearly establishing the objectives the investor intends to achieve. Accumulating capital to supplement retirement income is one of the most common goals, but there can be others, such as reducing taxes, purchasing a home, planning for one's estate, or providing for loved ones in case of illness or one's own death.
Subsequently, the objectives will be classified according to their assigned priority, first qualitatively and then quantified into concrete proposals. According to Félix Quintana, CEO of Renta 4 SGIIC, "each objective takes time to achieve and time to enjoy, which will influence how it is financed and how the accumulated amount is spent. We can accumulate the money to spend (or invest) it all at once (car, house) or spend it periodically (for children's education, retirement)."
The next step is to analyze the resources currently available (financial and non-financial assets, disposable income, returns on current financial investments, etc.) and project them over the duration of the financial planning period. At this stage, we will compare the objectives we have set with the resources we have available to determine the plan's feasibility. It will be crucial to consider not only the projected return on our investments but also other factors such as inflation, the investor's life expectancy, and future tax implications.
For each objective, a specific financial plan will be created that will be framed within the overall financial plan since "each investment strategy for those savings will be different depending on the objective: we will choose a different level of risk to finance the purchase of a car in 6 months than to finance retirement in 30 years" according to Félix Quintana.
It's essential to maintain a balance among all the assets in your portfolio. In this regard, it's crucial not to confuse asset allocation with diversification. Asset allocation allows you to create the optimal investment portfolio for each client. There are essentially six types of portfolios.
1. Preservation of capital: maintenance of investment and purchasing power.
2. Current income: the objective is to achieve a continuous and secure income stream. Regarding the stocks in the portfolio, investments are made in high-capitalization, highly solvent stocks with an average dividend yield 25% higher than the average of the market in which they are listed. Regarding the bonds in the portfolio, they are rated with the best credit ratings and have a duration of no more than 8 years.
3. Income and Growth: This is a balanced portfolio of bonds and stocks aimed at achieving long-term capital appreciation and current income. It can invest in commodities and extend the duration of its bonds to 10 years, thereby lowering their credit rating.
4. Long-term growth: Its objective is to achieve above-average returns. It differs from the previous option primarily in the possibility of including variable-rate preferred shares, which can mitigate periods of rising interest rates.
5. Aggressive growth: pursues the same objective as the previous one but with greater emphasis on equities.
6. Capital appreciation: The goal is to maximize capital gains within a year. The investor is willing to take advantage of large market movements and make a greater commitment to a single asset class.
Once the right portfolio has been chosen, it's time to configure it. In 1950, Harry Markovitz developed his "Portfolio Selection Theory," which is the basis for achieving proper diversification across all sectors and geographical areas within the same asset class.
Finally, the appropriate financial vehicle for each moment will be specified: a unit linked, a pension plan, a SIMCAV, etc.
Unit Linked products offer the advantage of being able to make movements between the different funds that make them up without having to realize capital gains until the time of the sale of the Unit Linked product itself.
In this way, a true "boutique" of funds can be created based on the client's profile. Two portfolio models are shown in Figure 1.
In this regard, it is also worth highlighting the importance of financial derivatives, both for their potential to multiply portfolio returns at specific times when the market warrants it, and for their use as a portfolio hedge, which is especially important for tax purposes. Thus, the Spanish regulatory body, Meff, created "mini-Ibex" contracts in November, which allow investors and managers "better access to hedging and speculating with their portfolios in bullish, bearish, or stable situations," according to Meff's Commercial Director, Manuel Andrade. Something similar could be said about warrants.
Once the Plan has been drawn up, all that remains is to implement it and establish a schedule of regular meetings between the advisor and the investor in order to evaluate its results.
Factors to consider.
Time, inflation, the benefits of compound interest, taxation, and the risk-return ratio are the key factors to consider when developing a sound financial plan. It's never too late to start an investment plan, and history shows that the sooner you begin, the greater the returns, since ultimately, the goal of any investment is to protect your wealth from two "moths": inflation and taxes.
One of the best ways to combat these challenges is to make time work in our favor, and this is possible thanks to compound interest. This essentially means that once the interest earned on an investment is accumulated, it is added to the principal. Therefore, the return on the next investment will be calculated not only on the principal but also on the sum of the principal plus the interest from the previous year. In other words, the sooner you start investing, the better, as the impact on the final return will be greater for the same amount of savings effort.
Figure 2 shows the evolution of $1000 invested in the indicated categories, with reinvestment of all results during the period from 12/31/1975 to 12/31/2000.
A common investment strategy is "market timing," which involves trying to optimize investments on days when the market is cheaper. However, "trying to invest solely by predicting market movements can be a risky strategy, because nobody really knows what will happen tomorrow," says Rafael Bonmatí, Institutional Sales Director at Pioneer Spain. One way to reduce investment risk is to invest periodically. This method, called "Dollar Cost Averaging," allows the weighted average price to more closely reflect the chosen market trend, minimizing investment volatility. This is due to two reasons:
– In the long term there is no great difference between having invested on the best day of each year (the cheapest), the worst (the most expensive) or any other day (in our example, January 1st) (Figure 3).
– In the long term, the possibility of not being invested while waiting for the optimal moment and missing the best days on the stock market can significantly affect the final return of our portfolio. (Figure 4).
Therefore, it is also necessary to maintain the direction initially chosen. In other words, we must not be swayed by market turbulence and must maintain a degree of detachment in our decisions, avoiding being swept away by either euphoric or depressive phases. That is to say, to capitalize on the growth potential of investment funds, one must be prepared to hold the investment even during short-term fluctuations.
Furthermore, history shows that the behavior of an investment in the short term can be very different from that experienced in the long term.
Logically, this does not imply that a periodic review of portfolios or a rotation of sectors or assets that may be more convenient at any given time will not be carried out.
In short, it is important to highlight that, historically, riskier assets have offered higher returns, so it seems obvious to conclude that if the maturity period of our investment is long, we should not influence our decision based on market fluctuations (erratic and unpredictable in many cases) and should instead prioritize assets with higher estimated returns over those periods in our portfolio.
Figure 5 details the evolution of different types of investments over the last 50 years.
A personal relationship.
Regardless of the specific working methodology of each financial institution, modern financial planning is based on a personal relationship between the client and the advisor, in which each party must fulfill their obligations. The client must fully and openly disclose their financial situation and follow the advisor's guidelines, while the advisor must safeguard the client's interests and make relevant recommendations with complete objectivity and independence.
And, of course, this personal relationship, which is based on the relationship between client and advisor, not between client and salesperson, must place special emphasis on the feasibility of the established objectives. The speculative bubble of the late 90s created the illusion of lavish appreciation without any risk, since all crises were quickly resolved by Greenspan, leading many savers to confuse value with price and speculation with investment.
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