Achieving the highest probability of success in money and life

TWO weeks ago, I was once again in Guangzhou. Besides meeting government officials, I had the opportunity to spend time in several Chinese financial institutions to share how advice should be given.

Coincidentally, I arrived in the city on Oct 8, when Chinese stocks rose 5.9 per cent as if to welcome me. The rise was fuelled by the government’s pledge of fiscal stimulus. Because Chinese markets have suffered a three-year drought, financial institutions were busily putting in trades for investors who did not want to miss this rally, convinced that the rebound was finally happening.

At lunch the next day, one of the guests said that he had overheard a group of “aunties” at breakfast, discussing the stock markets. After a lot of chatter, one of them concluded the discussion with a serious message – that they were to take their savings to buy into the markets that same day and by a certain time. With that, they quickly departed.

In another story at dinner, I was told that an investment adviser had set up a makeshift stall at a night market and convinced a large crowd of people to open trading accounts with him. I was dumbfounded by both stories.

Shortly after the initial government announcement, the Chinese National Development and Reform Commission provided more details on the stimulus. The market retreated by 7.1 per cent on Oct 9, indicating that the measures were perceived as insufficient.

Following this decline, the stock market fluctuated. It rose by 1.1 per cent on Oct 10 and dropped 2.8 per cent on Oct 11, as the Ministry of Finance (MOF) prepared to unveil additional fiscal stimulus in a briefing scheduled for Oct 12.

Because there were significant concerns that the recent rally could reverse if the measures announced at the MOF briefing did not meet market expectations, the CSI 300 experienced its worst week since July this year, falling by 3.3 per cent for the week.

I felt sad for those aunties and the hundreds who had bought into the stock market after opening accounts at the night market.

In my firm, we manage monies for our clients to enable them to achieve their non-negotiable life goals and events. Because the goals are non-negotiable, we have to use an evidence-based approach that gives clients the highest probability of success. There are eight steps in this systematic approach:

• Invest only in asset classes that, from empirical evidence, will generate long-term expected returns. For an investment to generate long-term returns, it must participate in and contribute to global economic production. Otherwise, we should not expect such long-run returns. From evidence, equities and bonds are examples of such asset classes. Both are avenues for investors to provide capital for companies’ business activities. The companies are expected to create value through the services or goods they deliver. Investors receive returns if the businesses are successful, and lose money if they are unsuccessful.
• Use a scientific method to estimate future returns. Having a scientific basis to estimate the future expected returns of asset classes is important so that the return numbers used for wealth planning are more robust. If the returns do not come in as expected, we would know what went wrong and what adjustments are necessary. We use the Ibbotson-Chen model to estimate equities return, and the term premium of bonds of different maturities to estimate bond returns.
• Create portfolios of different asset allocations, risk levels and returns. After determining the estimated returns of each asset class, we can study various combinations of asset classes to ascertain the expected returns and risk level of each portfolio.
• Find suitable instruments that will deliver the expected returns with higher certainty. Based on evidence, we pick the instruments that can reliably deliver returns over the long term. We use them to express the asset allocations of different portfolios. For now, we use only low-cost, non-forecasting funds.
• Understand clients’ life goals and events. We help clients gain clarity about their non-negotiable life goals (we also call them “ikigai” goals) and events (such as retirement), and ascertain the amount of money needed to achieve them. Based on their current financial situation and relationship with money, we are able to establish their need for returns, their ability to take risk to get the returns and their willingness to take risk.
• Find suitable portfolios to deliver money when needed. We invest using suitable portfolios (from steps 3 and 4) that are expected to deliver the returns that clients need, and at a level of risk where clients can stay invested to reap the required returns.
• Help clients stay invested. Once clients are invested, the hardest part is to help them stay invested through the markets’ ups and downs. Although they have the right portfolios (step 6) that would theoretically help them stay invested, when markets become volatile, theory gets thrown out of the window. The ongoing process involves a lot of financial education and coaching to help clients stay on course.
• Make adjustments. Because we are investing for the long term, we must expect changes in life circumstances, geopolitical situations, and markets, among others. Investments which may have done well in the past may no longer perform. Instruments which were previously not available may now become available. Past estimated returns (in step 2) may become irrelevant, and this affects clients’ wealth plans. Thus, ongoing monitoring and adjustments need to be made to the planning assumptions and investment portfolios.

Many investors are interested only in how to get the highest returns. We think it is more important to have enough money when they need it, and to be able to use the money to live out their life goals and ikigai. This cannot be done by forecasting markets, which is essentially gambling, or by simply buying a bunch of products.

Only through a systematic process that is regularly fine-tuned can one achieve the highest probability of success both in money and life. Yes, it is laborious, but my experience tells me there is no better way.

The writer is chief executive of Providend, South-east Asia’s first fee-only comprehensive wealth advisory firm