Investing discussions from the Moneyweek workshop

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Queen Elizabeth II conference centre, central London
Queen Elizabeth II conference centre, central London

I attended the Money week workshop which was part of the world money show.  It was held at the Queen Elizabeth II conference centre in central London on the 8th November. There were four presentations but I’m going to focus on the ones given by Merryn Somerset Webb and Ed Bowsher on the following topics:

•The impact of quantitative easing on the economy
• Asset allocation

These two topics affect us all greatly whether we know it or not. ‘Quantitative easing’ (QE) has been hailed by bankers and politicians as the answer to our countries economic problems and asset allocation is an un loved topic that has caused many unsuspecting investors(I mean you and me) a lot of pain due to our ignorance of the subject.

During the sessions, I began to wonder and thought, what’s my financial situation like and where am I heading?  What follows is a summary of the topics covered.

The impact of quantitative easing on the economy, Merryn Sommerset Webb

Qualitative_Impact_of_QE
Qualitative_Impact_of_QE

The following chart was taken from the Bank of England’s quarterly bulletin report, 2011 Q3 | Volume 51 No. 3 and is a reflection of their own findings.

In order to understand the above chart, it’s best to focus on one coloured light at a time. The vertical dotted line shows what happens when the Bank of England(BoE) stops its QE programme. So starting with the red line which represents ‘real asset prices’, i.e property, land etc, you can see that during the early impact phase of QE, asset prices rise quickly as the BoE injects liquidity into the economy. This generally makes people who own property and real assets feel good so they in turn go out and borrow or spend more money into the economy. However when the QE stops, real asset prices decline sharply over time.

The dark blue line is ‘Broad money’ which is the total amount of money swishing around in the whole economy. As you can see, it rises sharply during QE and then stays flat. Not much to say here apart from generally speaking lots more money in the economy usually leads to inflation or higher asset or consumer prices.

The Light purple line is ‘nominal demand’ or the demand for money. I.e the demand for investments in the economy held in cash goes up versus other assets like property, precious metals etc. Generally high money demand is good as it increases liquidity in the system which is essential for the normal buying and selling of goods and services in an economy.

The next line is the yellow line, ‘Real GDP’. It’s very telling to see that even with hundreds of billions of pounds pumped into the system through QE, the real GDP of the UK will only go up marginally and eventually tail off quickly after the QE has stopped. Thus, without any real GDP growth, the likelihood of new jobs being created is greatly reduced.

‘Consumer prices’, only go one way over time, up and up ! This happens even after the Bank of England has stopped its QE program.

The green line represents ‘inflation’ which rises and falls in a relatively smooth curve. I’m not sure I agree with this as surely real asset and consumer prices rising would constitute inflation? This does seem contradictory, and the truth is that each country has its own way of calculating inflation. You can find more info on UK inflation at my ‘Beware the inflation thief in your pocket’ post. Needless to say, property price increases are not used when calculating inflation in the UK.

It is apparent that QE in the long term does not really do much good for the UK economy. It Inflates asset prices for a while, thus benefiting a small proportion of the population, but for the majority of the population who do not own property or real assets, consumer prices will rise and an increase in real GDP will be marginal.

Asset Allocation, Ed Bowsher

This is often seen as a boring subject and frankly, it kinda is. However at least a basic grasp of it is essential in helping you avoid investing disaster in the future.

Why should you Asset allocate ?
• To reduce your risk and improve your returns on your investments.

The different types:

Strategic asset allocation
• This is a long term strategy that allows you to ignore market volatility and the day to day price gyrations in the markets.

Tactical asset Allocation
• This is a short/medium term strategy that allocates your assets to reflect the current market conditions.

It’s generally best to begin with a strategic asset allocation and then adjust it as you go along.

Essential questions to ask yourself before you begin:

• Why are you investing and over what time period?
(The general rule is, if you are rich and have more time, take more risk)
• How much cash do you have now?
• Do you own any pensions or other assets?
• What is your attitude to risk?
(Are you risk averse, or like some excitement in your investing life ?)

The Main asset classes

• Equities (shares, mutual funds, index trackers etc)
• Bonds
• property
• Cash
• Gold and silver/other commodities

Equities

These generally come with higher risk and higher volatility. They do tend to deliver higher returns and if you invest for the long-term you may reduce your risk. Other risk minimising strategies are to invest in funds as opposed to individual shares and diversifying your investments into different sectors.

Bonds

UK gilts are generally seen as low-risk as it’s not likely that the UK government will default on its obligations. However bonds from other countries, especially the emerging markets can be seen as risky. Corporate bonds have got a wide spread between risky and not. It very much depends on the quality of the company issuing the bond.

Property

Much loved by many investors, especially here in the UK where we seem to be quite property mad! It has delivered some good returns over the last few decades but this is not indicative for the future. New stringent lending criteria by the banks and the possibility of a future increase in interest rates will have an impact on the returns possible with property investment.

Gold and silver

Mostly seen as an insurance investment against disaster in the markets. I.e. if there was a sudden and dramatic drop in the FTSE 100, investors tend to flock to the historic safe haven that is gold and silver.

Ed Bowsher then went on to present some numerical examples to asset allocation. He described these as ‘back of an envelope’ ideas, so take these figures with a pinch of salt and as a general guide. I don’t necessarily agree with these numbers myself but as everyone is different, they could be a good starting point.

Risk tolerant, long-term strategy

• Equities – 75%
• Bonds – 10%
• Cash – 10%
• Gold – 5%

Risk averse, short-term strategy

• Equities – 20%
• Bonds – 40%
• Gold – 5%
• Cash – 35%

Some final thoughts regarding the different asset classes:

• Due to the Federal reserve’s continuous QE programme in the US, US equities are currently looking rather expensive.
• Property prices are currently very high in the UK so maybe not the best time to jump in as far as maximising your returns go.

• Bonds are riskier than normal due to the massive levels of debt we have here in the Uk.
• Due to the historically low interest rates, returns on cash savings are very poor, perhaps peer-to-peer lending i.e. crowdfunding programs such as ‘Zopa’ might be worth a look.
• After continuously rising for a decade, the gold price has fallen a long way to 2010 levels. Perhaps this is a good time to buy as it appears that gold is relatively undervalued presently.

Is it time to ponder where the UK economy is headed and what this means for you and your family? Are your assets well allocated to weather any financial storms or take advantage of any economic miss allocations. If you have any comments, go ahead and share your thoughts in the comment section below.

Soti Coker is the founder and editor of smartMoneytree. Learn more about him here and connect with him on Twitter.

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