People's reasoning almost never works according to certain patterns; man does not behave in a perfectly rational way (fortunately). A fraction of the financial world, the part that deals with behavioral finance, has long since realized this. In fact, when it comes to managing their money, people typically reason using "Mental Accounts” (Mental Accounts) which Zia Mame has already written about on the Advise Only blog (Mental accounts i, Mental accounts II)
What does it mean? In simple terms one does not look at one's assets in its entirety, but mentally breaks it down into many accounts, for example, one for current expenses, one for retirement savings, and so on. It's about have several portfolios defined with a well-defined goal in mind.
Following this line of thinking was once thought to damage the overall efficiency of the total portfolio (assets). However, fortunately, this is not the case: it is possible to set savings using Mental Accounts and at the same time have an efficient asset allocation (if you are a financial “geek” read here, and find out the big name behind this very modern idea).
For the financial advisors of Advise Only, the main road is precisely this: meet the real needs of savers, therefore we have evaluated what are the typical needs of you savers and have identified a dozen typical Mental Accounts (which can be distinguished by the practical implementation methods).
The first portfolio that is proposed has a common goal for many savers: build capital for the future of children.
Target: making sure that a young child (eg 5-10 years old) has enough capital to face university or post-university studies more serenely, or to start his own business, in short, his future.
Time horizon: about 10 years.
Portfolio structure: “Core”-“Satellite”, i.e. a central strategic portfolio, accompanied by a tactical portfolio, which changes a little more frequently.
Risk: – the portfolio structure is such that minimize the likelihood of having capital losses at maturity, to avoid what Warren Buffett calls "the definitive loss of capital" which would frustrate the efforts made by the family (if you are interested in understanding how we did it, in technical details, send an email to ilblog@adviseonly.com);
– the focus is onfinal goal, therefore the portfolio can be relatively indifferent to "trajectory risk", represented by the volatility of returns over the life of the investment; Instead, great attention has been paid to diversification of the main long-term risk factors borne by the portfolio, i.e default risk of bond issuers, political/country risk, risk of erosion from inflation.
Cash Flows: unimportant, especially at the beginning. Instead, they may come in handy towards the end of the period (e.g. for the periodic payment of university fees).
Where does it invest and why:
1) wallet “Core: – equities of developed and emerging countries, to benefit from a reasonable equity risk premium, given the long time frame, and some inflation protection;
– Euro area government bonds, both “Core” (for the best solidity in terms of credit risk), and “Periphery” (for the best returns);
– Italian bonds linked to inflation, to provide some protection from the inflation risk specific to an Italian family;
– bonds denominated in non-Euro currencies, to provide defense in the event of an exit from the Euro (an unlikely but possible event);
2) wallet “Satellite: – the global equity sector of consumer goods, one of the least impacted by the recession;
- bonds of emerging countries, which have better economic prospects and healthier public finances than many developed countries
- European corporate bonds, for similar considerations, but relating to the structure of corporate debt.
You just have to go up www.adviseonly.com in the Market Analysis / Investment Ideas section and discover the details of the portfolio.
Consider that, if it is true that savings can be broken up into many "Mental Accounts", it is still important to have an overall view of the heritage, which you can do easily (and for free) on the Advise Only website, by accessing the "Portfolios" area and clicking on the last icon on the right (with the label "Unified Treemaps”): it doesn't matter how many wallets you have, the system will calculate all the your assets as a single maxi-portfolio.
One last thing: not everyone can or wants to create capital for their children with a single initial investment (the "PIC"); many would prefer to build capital little by little over time (“PAC”). So, soon, a post will be written on these web pages on how to pursue the same goal gradually.
