Why diversification is the only investment outlook that matters
TB Wise Multi-Asset Growth fund manager Vincent Ropers gives us an update on his exposure to value...
Do you overestimate the probability of your success? Chances are yes, because of what’s termed ‘optimism bias’. This bias refers to our tendency to overestimate our likelihood of experiencing positive events and underestimate our likelihood of experiencing negative events.
Of course, it’s necessary to have some optimism. Optimism encourages us to take risk or to persevere – even in the face of hardship or rejection. But it’s important to be aware of how our optimism can blind us to negative outcomes. It’s a combination of optimism bias and decision fatigue which often causes people to postpone saving money for retirement and ultimately not have enough and be forced to work longer.
“Optimism is normal, but some fortunate people are more optimistic than the rest of us. If you are generally endowed with an optimistic bias, you hardly need to be told that you’re a lucky person – you already feel fortunate.”
— Daniel Kahneman, psychologist and economist
It’s not that people don’t have a sense of urgency about saving for their retirement. Many aspire to save for the future and most understand the responsibility that comes with it. However, it doesn’t always translate into action.
There are several reasons why someone might not have enough for retirement. And it isn’t necessarily down to their level of income. I can be down to their knowledge and motivation to save. For many, setting a clear target is really hard. Although we understand that people retire when they turn 66, the reality is more complicated. For one, people are living for longer.
After they retire, some people tend to increase their spending either through traveling or simply indulging in all the hobbies and interests they dreamed about for the last 40 years while sitting behind a desk. Some downsize significantly without kids at home – and may find their spending falls dramatically. All these factors mean it’s hard to accurately plan for retirement. In other words, there is no “magic number” or specific target to aim for.
Saving in general is always problematic as abstract goals are often the most difficult for our brains to pursue. Retirement fits right into this category. I for one can’t imagine retirement but I know, in the abstract, I’ll need some amount of money for however I choose to spend my time. Where retirement savings are concerned, without “the number” to aim at, the pursuit is hampered by many.
Often, when people make a budget or even list their financial goals, they focus on the nearer-term, more specific goals. Those in their 30s may focus on saving for a down-payment on a house, those in their 40s may prioritise their family and children’s education. In your 50s you may look towards more discretionary purchases like holidays or maybe even a second home. But when all these other things take precedence, they just push retirement further and further back on the agenda.
Many of us don’t understand the importance of exponential growth, or compounding. Psychologists have found that our default understanding of problem solving is linear in nature. This means that we associate our savings in a linear fashion, thus actually underestimating how much our savings could be worth in the future. The result of this underestimation is that it has a negative impact on our motivation to save now.
But as Albert Einstein once said, compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t pays it.
Here is an example of how it works: In the first year I invest £1000. It grows by 5% and at the end of the year I have £1,050. The next year my pot of money grows by 5% again. At the end of that year, I don’t have £1,100 as our brains may initially think – I have £1,102.50 because my interest from the previous year has grown too. Over many years, compounding can make a huge difference to our retirement savings.
Still dithering about getting started? I’m not surprised. After all, if we can’t even make a decision about dinner, how are we meant to make decisions that could impact our future so greatly? To alleviate this pressure, a multi-asset fund might be an option. Multi-asset funds typically offer you a wide range of shares, bonds, property and other types of investment from various geographies, in one simple product. This helps with diversification and takes very little effort – all you have to do is pick a fund and an expert manager makes the rest of the decisions for you.
You can find all our Elite Rated and Radar multi-asset funds here, and the top five performers this year are listed below.
|Jupiter Merlin Growth Portfolio||15.84%|
|Premier Miton Diversified Growth||14.84%|
|TB Wise Multi-Asset Growth||14.39%|
|Jupiter Merlin Balanced Portfolio||12.89%|
|Liontrust Sustainable Future Managed||11.86%|
*Source: FE fundinfo, total returns in sterling, 1 Jan 2021 to 28 Nov 2021