Investment return volatility is poorly understood
Most investors understand that in order to
Is it possible that Investor B, who is accepting a lower average return, could end up better off? Counterintuitively, yes! For this example, Investor B (who invested in a balanced portfolio of cash and shares) ended up much better off than Investor A (who invested in Australian shares). Wealth Paths
But it is only one of an infinite number of wealth paths that could be generated by varying the assumptions regarding cash inflows and outflows over the investment period.
Long term cash flow management as a volatility antidote
The above examples show that volatility can affect wealth outcomes in unexpected (and, potentially, financially catastrophic) ways. And this applies not only in a forward looking sense, when return volatility is unknown.
It can also be the case even when average investment returns and return volatility are known in advance. The interaction of the pattern of investment returns (i.e. volatilty) with cash inflows to and cash outflows from your investment portfolio will drive a vast range of potential wealth paths.
It is impossible to know the pattern of future investment returns. However, it is possible to make some reasonable predictions about your expected long term cash flows, both in terms of amount and timing.
In our view, a smart investment strategy should manage the investment of these cashflows to mitgate the risk of return volatility. Rather than investing only when cash is available or selling investments only when funds are needed, long term cash flow management offers the opportunity to smooth investment flows.
This reduces your exposure to severe adverse investment return volatility. As a result, you reduce the volatility of your investment wealth and increase the chances of achieving your desired financial future.
John Raymond Leske –
About the Author:
Wealth Foundations is an independently owned personal financial advisory firm that offers wealth management and strategic financial planning services. For more information, visit Wealth Advisers .