Where to Invest—Understanding the Basics of Top-Down Investing

Determining where to invest can be a daunting endeavour. What should be your long-term investing strategy? Should you choose a European fund, or country-specific foreign stocks? What are your investment options? These can be challenging questions, and in many ways they should be. After all, the investment universe is broad, includes options around the entire globe and offers almost innumerable possible options. Even if you look at equities alone, there are tens of thousands to choose from¹. So, what’s the best place to start your investment decision-making process in order to achieve your investing goals? In this article we help you understand some of the factors to consider, along with the basics of top-down investing.

Goals and Asset Allocation

In our experience, the most important determinant of investing success, in Europe and across the globe, is asset allocation—this is the mix of stocks, bonds, cash and other securities in your portfolio.

However, to determine where to invest and which mix of countries, regions and asset classes is right for you, you must first identify your investing goals. For most European investors—in fact for just about every investor on the planet—potential investment goals can be boiled down to one of the following (or some combination thereof):

  • To maintain wealth and ensure cash flow: If these are your goals you should ask yourself the following: Have you considered the long-term impact of inflation? What will happen if you live longer than you expect? What if you have unexpected medical or care needs or any other unplanned for financial demands? Is your "emergency fund" really going to be useful in the event of financial hardship?
  • To grow wealth: Growth-focused investors should have a long-view that puts their ultimate financial goals above any short-term volatility in the market. It requires discipline but history shows us that over time, pursuing growth provides the best long-term investment returns.
  • To spend everything: This is not a typical goal, but is not unheard of. It inevitably requires a prudent strategy. If you get your timing wrong, you risk running out of money.
  • To build a legacy: Building a legacy, whether for heirs or for charity, is an admirable goal that can ensure your wealth provides for others after you have gone. However, it requires growth and prudence.

Investment Time Horizon

When identifying your investment time horizon (we define this as how long you need your investment income to last), you should remember that you may, and probably will, live longer than you think. Medical advancements in Europe mean that people are living longer than at almost any point in history. If you underestimate your time horizon, you risk running out of money. And remember, if your money is intended to provide for others, you should not consider your lifespan alone; you should consider your spouse's, partner's or any dependents' potential life expectancy as well.

The longer your projected time horizon, the more likely it is you will need a growth-focused investment strategy, and this will probably mean you need to invest in more growth-focused assets like equities. If you have a shorter time horizon and need more cash flow, you will probably require some lower-volatility assets such as fixed interest to help you meet short-term goals and provide you with regular money as and when you need it.

Pick a Benchmark Before Selecting Securities

Knowing what types of assets to own is only the first step— it doesn’t tell you exactly where to invest. Let’s say you need to own equities to reach your investing goals—as many investors do— the first step would be to select a benchmark, as owning equities without anything to compare returns with can prove to be a rudderless strategy. By selecting benchmarks you are able to measure risk and set performance expectations.

This process of minimising and managing potential risk is just as much a part of successful investing as maximising the potential for gains. If you select an appropriate benchmark, you will be better able to diversify across countries and sectors, which will help you to spread risk and make the most of global opportunities—hopefully increasing the possibility of enjoying positive returns. If you are an active investor, you aim to add value to your portfolio relative to the selected benchmark. This is done by emphasising or de-emphasising particular components of the benchmark by overweighting parts you think will do well and underweighting parts you think will underperform.

Don’t Concentrate Risk

Humans are innately conservative creatures. It is part of our evolutionary hardwiring. However, this risk-averse part of our conditioning is ill-suited to negotiating the investment choices seen in different parts of the market cycle. For example, if you concentrate your holdings in a single familiar country, such as France or Germany, or in a single geographic area, the Eurozone for example, this exposes your portfolio to “concentration risk” which can also include:

  • Economic risk: The economy falters in the country or region in which you have all or most of your investments.
  • Environmental risk: Any single environmental event such as a natural disaster, hurricane, flood or tsunami can have significant near-term impact, though it often tends to be short-lived.
  • Political risk: Changes in political leadership, and the ensuing economic, trade or monetary policy can negatively affect business and trade and impair the long-term performance of overly concentrated portfolios.

All three of the above have the ability to quickly wipe away any positive returns and dividend yields which you may have accumulated over a given time.

Make the Most of the Global Economy

In many ways diversification is simply a reflection of the global economy we live in. Markets in countries around Europe and across the world that you may have thought previously would not present good investment opportunities emerge with regularity and post impressive growth and returns. Your portfolio should be alive to these or you risk missing out on important global investment opportunities. But always consider the variables which could affect market volatility. For instance, did the French Election affect mutual funds? Is the UK's exit from the European Union going to hinder your equity holdings?

New stocks and new funds in European and global markets should be considered and investigated. If you invest in securities from too narrow a geographic area, you risk missing out on fresh opportunities. 

Invest More in Promising Areas

In order to benefit from well-performing securities, investors must essentially invest in the parts of the market they think will do best based on thorough market research. Look at the landscape—without historical data to go on this can seem risky, but once you understand how to formulate your options, you will have a better idea of where to invest.

So, what drives stock prices? Through every financial crisis, fund collapse and bull frenzy, supply and demand has always been the thing that drives stock prices. In the long-term, supply can expand or contract infinitely through numerous factors, including initial public offerings (when a private company decides publicly offer shares), secondary offerings (when an already public company offers new shares), buybacks (when a company decides to repurchase its own shares back), and mergers and acquisitions. In the short term, demand moves prices. Demand has three fundamental drivers:

  • Political: A hung parliament, Brexit, the ousting of a government by military coup—these and more have the power to drive investors to buy or sell.
  • Economic: Although the economy and the equity market are not the same thing, economic factors such as interest rates, global trade and business cycles all have the ability to drive demand.
  • Sentiment: Investor psychology and an inability to weather volatility is a distinct driver. Emotional reactions to media stories can cause panic buying and selling at any given time and this of course affects prices.

If you can identify mismatches between fundamentals and investor perception, you may be able to find ways to outperform your benchmark. Remember, most widely known information is already priced into markets. To outperform, you have to know information others don’t, or interpret widely known information differently from the crowd—your fund manager or investment adviser should have their ears to the ground on this and other European and global market matters.

Invest in Less Promising Areas

A good investor is also a humble investor. Always accept that you could be wrong.

If you have only ever invested in the parts of the market you think will do best, and you’re predictions are wrong, you could set yourself back from your goals. If your benchmark has exposure to other parts of the market and your portfolio shies away from these, you run the risk of missing out on the opportunity for extra returns. Informed diversification is likely to be critical in achieving your financial and retirement goals.

Helping You Decide Where to Invest

At Fisher Investments UK, we aim to provide investor education through our investment guides and other services geared towards helping you reach your personal financial goals.

Fisher Investments UK can help you begin your investment planning journey. If you are a qualified investor with at least £250,000 of investible assets, our professionals may be able to evaluate your portfolio, asset allocation and investment strategy to help you reach your long-term financial goals.

For more information, feel free to download one of our guides as the first of our ongoing insights or contact us to speak with one of our professionals today.

¹Source: FactSet, as of 29/06/2018.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.