Investing in Equities: The First Steps
Establish your investment plan
Before you start to build your portfolio, you should first clearly determine your investment objectives. Some of the key issues that you need to consider include your investment time frame, your appetite for risk, your requirement for income versus capital growth and the tax implications of your transactions.
Know your time horizon
Determining your time horizon for investment is critical to your asset selection, as the performance of the various asset classes can differ markedly depending on the time frame involved.
Younger investors should favour equities
To ascertain your appropriate asset structure, you may wish to consider what position you are at in the life cycle of investment. If you are in your early years, much of your income may be required to meet the expense of mortgage payments and the likely costs associated with a young family. However, it is wise to use any surplus resources you may have to lay the foundations for your long-term future. You should be able to withstand greater volatility in the knowledge that equities will outperform other options over the longer term. Consequently, your portfolio should be heavily weighted towards equities (See Graph 1a).
Middle-aged investors should continue to favour equities
As you approach the middle stages of life, your income will probably be nearing its peak, while at the same time expenses should be declining. This is a combination of circumstances that should allow you to invest more heavily. However, keeping in mind that retirement is inevitable, your investment approach should be more conservative since at this stage in life it is important to protect your capital. Thus, your portfolio is likely to contain a balance of equities, bonds and cash (see Graph 1b).
Older investors may require capital growth and income
As retirement approaches, capital growth should remain important, especially given the trend towards early retirement and increasing longevity. Yet, as the provision of a secure income assumes greater priority, your holdings of bonds may increase (see Graph 1c).
No rigid solutions
It is important to bear in mind that the above illustrations are merely indicative. Although age-based generalisations are a useful starting point, they do not provide definitive solutions to the investment challenge which will vary from person to person. For example, many people that are approaching retirement have their income needs fully satisfied by their pension. Therefore they are still keen to favour capital growth rather than income generation from their investments. As people's lives evolve, flexibility is clearly required to accommodate competing priorities and changes in circumstances.
| Graph 1: Asset allocation and the life cycle of investment | ||
|---|---|---|
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A. Early Life (Under 40) |
B. Mid Life (40-60) |
C. Late Life (Over 60) |
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| Capital growth should be your primary objective | Increase weighting towards bonds reflecting a more prudent stance | Income needs of primary importance |
| Little requirement for income | Little requirement for income | Profile of specific equity content adjusted to safeguard capital preservation |
| Small element of cash for unexpected rainy days |
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Maintain desire for capital growth |
Your Tolerance For Risk
Understanding your attitude to risk
Your comfort level with investment risk is paramount to how aggressively or conservatively you choose to invest. However, it can be difficult for you as an investor to ascertain your individual appetite for risk. While there are no specific criteria to answer this question, your character will somewhat influence your risk profile. To help ascertain your attitude, you may wish to ask yourself:
- What would your attitude be to a fall of 20% in the stock market?
- Would your instincts be to cut your losses or would you consider this a buying opportunity?
- Could you afford to take a large loss if you unexpectedly had to sell your portfolio?
- How likely is it that you may have to call on these funds?
- What would your attitude be to missing an investment opportunity?
Although the overall issue of risk is somewhat arbitrary, it is very important that you are comfortable with the level of risk your investment decisions embrace.
Tax Implications
Tax structure is biased towards capital growth
It is important also to bear in mind that different types of investment are subject to differing tax implications. For example, capital gains are currently taxed at 20% in Ireland whereas income is taxed at rates in excess of 40% for most investors. Historically, equity returns have primarily taken the form of capital gains. This contrasts with bonds, where the greater proportion of return is derived from interest income which is taxed at higher personal rates. This means that for the majority of Irish tax payers, all other things being equal, equities are an even more attractive investment, from a tax perspective, than bonds.
