English Retirement planning

The Guide Finances investment model for a robust personal financial planning

You can consider investing in markets with abnormally cheap currencies and look more closely at ratios that consider the share prices.

The world of investing is not without its dangers, and personal retirement planning is not an easy venture. To navigate the markets without too much trouble, a general understanding of your situation and a solid approach is necessary. For this purpose, we will propose below an investment model based on the most judicious proposals of the practice and the academic world for the private investor. There are specificities for Switzerland at the end of the article, but the generic model is applicable to any investor who wishes to strengthen his pension on an individual basis.

The dangers of the financial world

You have to take control of your finances to avoid being fleeced like turkeys by private service providers and state authorities:

  • If you give them a free hand, unethical finance professionals will enrich themselves at your expense by offering you life insurance or products with ruinous commissions; even worse, Ponzi schemers will try to enroll you in programs that will ruin you while others run away with your money. Solid, long-established and trusted institutions that offer good value for money (see the financial toolbox) will help you avoid these pitfalls;
  • Governments are impoverishing future generations by not immediately reforming unsustainable pension systems while our life expectancy could still continue to increase significantly due to medical and technological advances. The tax authorities are also taking large amounts of money from your wealth in various ways. Finally, central banks are flooding the markets with liquidity and keeping rates low, impoverishing those who stay out of the stock market.

In the face of these dangers, a good model as proposed in this guide will allow you to ensure a solid foresight thanks to a good long-term asset allocation and management, a healthy diversification, a reasonably aggressive cost control and good investment tools (platform and vehicles).

Theoretical bases and inspirations of Guide Finances’ generic model

The personal investment model is based on the characteristics of the following approaches, which have stood the test of time and/or come from proven academic sources introduced in this book:

  • The simplistic model: Depending on the phase of life (start-up, accumulation, retirement), a naive asset allocation (such as 60% low volatility assets (bonds and pensions) and 40% risky assets (stocks) can be used. This is  not the most sensible and sophisticated solution. However, it is at least a starting point, because it is better to start with an insufficient plan than with no plan (or worse, to do nothing);
  • The Norwegian model emphasizes the virtues of a long-term passive approach. This strategy applied by the world’s largest sovereign wealth fund applies very well to small private investors;
  • The Canadian model reminds us to consider any obligations (such as fixed costs or large expenses in the future), to adopt a regular monitoring discipline and to diversify between different assets and currencies;
  • The history of the Yale model reminds us that past performance does not repeat itself and that alternative investments are difficult to dominate, even for sophisticated investors;
  • The Black-Litterman model allows advanced investors to move away from purely passive, market-reflective investing. In particular, when entire sectors become expensive (such as U.S. large caps in 2021) or when central banks overstep their prerogatives by flooding the markets, well-founded investors can incorporate subjective views within certain limits. In any case, an individual approach will be necessary.

The Pillars of the Finance Guide Model

Inspired by the above institutional approaches and inspirations, the bases of the Finance Guide model for private investors are the following:

  • You should follow the principles of a long-term passive approach and diversification between assets and currencies (more information under the article dedicated to the fundamental principles). This will reduce costs and avoid the risk of complete ruin. Look for low cost and transparent investments. You shall dedicate yourself to index investments and avoid too complex approaches. Many portfolio management models are difficult to implement at the individual level with a sophisticated asset allocation process where you can get lost. It is better to consider assets as stable and not stable. For this second category, you will invest in a diversified way by geography and currencies with entry points that will depend on the relative attractiveness of these markets and the balance between them.
  • Consider your asset allocation according to your life cycle. Your wealth will evolve according to your plans and your age. For the constitution and management of your portfolio, you can differentiate three stages of your life :

1) During the first phase of your wealth accumulation, the evolution of your investments and assets may be irregular. Try not to invest in too much concentration and stay within the ranges of a global portfolio (for currencies and countries). If you can afford them, take controlled risks with small caps if large caps are overvalued. After 4-5 years, you can start rebalancing your portfolio if you think your exposure to certain countries (e.g. UK or Germany) is too high;

2) In the second growth phase, orderly portfolio management will become more important: starting with a portfolio of a certain size (around CHF 200-300k), some rebalancing is possible. However, do not be too active, buy cheaper segments and try to fill the gaps in the asset allocation by taking into consideration your entire wealth;

3) At the time of retirement, a reduction in risk is necessary, since the state and company pension will be less than the income from your working life. You will need to obtain enough diversified sources of income to live freely and obtain the best possible care and medical services not covered by the public minimum to enjoy your wealth in good health. Your diversified wealth will allow you to exclude longevity risk (which materializes when your income does not cover your expenses) with a sufficient margin of safety, and eventually leave an inheritance or enjoy your wealth with new generations.

  • Preference for value investments. In the long term, it is necessary to consider prices and the return to normal of exaggerated returns. This way, a crash will affect you less, even if you will profit less in periods of strong growth. The opposite strategy (momentum/growth) may be worthwhile in times of central bank liquidity flood, but is more risky in times of correction. After considering the capital market assumptions of leading companies (see “Capital Market Expectations”), you may want to consider investing in markets with abnormally cheap currencies and look more closely at ratios that consider the share prices of companies in relation to their balance sheets or earnings (such as BtoV and PER). If today French and US large caps are very expensive (end of 2021), go for small caps, value, UK and Germany for example.
  • Personal and flexible model: Well-founded subjective views can be integrated within certain limits. When US big caps in 2021 become unaffordable, when corrections occur, when a reference currency falls sharply, when monetary policies push prices up, it becomes necessary to adapt one’s investment behavior. However, be careful not to blindly follow the herd: You have to keep control of your emotions and not throw a fundamentally good plan out the window. If you are just starting out, take a maximum simplicity approach. A personal model will allow you to include a real estate investment, for example, by following a solid and thorough investment process. An adaptive model will allow you, based on what you learn, to move into less crowded and more affordable investments (value, small and mid caps in 2021). There is no generic model, or right or wrong. The important thing is that it matches your objectives and your risk tolerance.

Application for the Swiss investor

You should consider this proposal for an individual investment model according to his or her situation and level of financial education. You shall also find a good balance between appropriate simplicity and complexity, between the market portfolio and subjective needs (such as tactical entry points due to market or forex movements, an investment in a private company or in real estate).

This model can then be refined according to your situation and jurisdiction. Here is an example of its application for Switzerland, which is based on the model presented for the international investor and integrates it into the Swiss pension system.

To meet certain obligations, your pension will probably not be sufficient. You will therefore need low-risk assets (pillars 1 and 2) to stabilize the portfolio and your pillar 3b entirely or partially composed of shares. The investor will therefore have to consider free savings, called pillar 3b:

  • Pillars 1 and 2 of the system provide some insurance and basic cost coverage
  • Pillar 3a is limited and will join 3b at retirement or earlier
  • The pillar 3b recommended by Guide Finances becomes a master piece of your pension plan and is composed of two main elements:

– The 3b (independent) allows a wider participation in the markets, with more risks, but also more potential returns.

– 3b real estate: Secures a home and does not depend on a landlord

Pillar 3b will therefore include the management of your securities portfolio and your home. This free pillar, if well managed, will make the difference between lower middle class and wealth allowing you leisure, material goods and access to the best medical care, so take care of your pillar 3b. This guide should accompany you in order to avoid big mistakes. Besides the theory, the implementation of the model is very important: Guide Finances highlights a very limited number of reputable services that you can find on the site. Indeed, we do not play with our finances by means of new gadgets or in laboratory projects, but look for solutions applicable to the greatest number, with a high level of security and at the best quality-price ratio.

History, Shocks, and Drifts: A New Approach to Portfolio Formation, Mark Kritzman and David Turkington, The Journal of Portfolio Management February 2022
New Perspective on Investment Models, The Journal of Portfolio Management, Investment Models 2021, Kees Koedijk and Alfred Slager