Investing for your pension: how to build a balanced portfolio

This article is republished from The Move Channel.

By the age of forty the European investors typically begin to think of creating a personal wealth fund, in other words a source of regular income, to guarantee a decent life after retirement. One of the ways to get such a source of income is to build an investment portfolio.

It’s hard to plan for life after work but building an investment portfolio is good way to guarantee financial stability late in life. Your assets should generate regular yields and gain value under your possession. That way, you increase your chances of being able to sell it later or leave it to your loved ones.

The ideal investment portfolio contains a varied collection of assets both by type and location: this will effectively protect you from economic and political risks linked to one asset class or country. For instance, investing in securities, metals and property will protect your assets for the risks linked to a single market and a single country.

The point of a portfolio is not to make quick money, but to maintain your funds and save them from devaluation as inflation rises. To make it work, your revenue should always cover your expenses and you should always participate a little in managing the investment. The idea behind it: have more time to dedicate to your family, travelling, leisure and even a business for your own pleasure — without worrying about the money.

Before building a portfolio, successful investors know their budget, risks and financing options. They also have a strategy to maximise yields and manage their investments.

1. Initial budget

Investors usually start to actively build an investment portfolio when they have at least €1M available because a smaller budget wouldn’t generate enough return. In Europe, for instance, the average yield on residential property is 4%.

2. Investment strategy

In order to expand the portfolio, you must decide how much you want to invest in the long-term and what investment vehicles to choose like property, bonds, stocks, etc. Let’s say you are ready to allocate €2M in 2015 and want to achieve €13M in fifteen years: estimate how much your portfolio should increase in value as well as your current regular income. Most likely, you’ll only have to invest €300,000 per year to achieve that €13M target. Alternatively, you could choose to make a few big investments over this period, like three properties worth €3–4M each (see my investment model here).

3. Risk assessment

Take note of the biggest and smallest risks linked to your investments and build your portfolio accordingly. When choosing real estate for example, if you need stable returns, you had better choose property with long-term rental contracts but lower yields. However, if you don’t, then short-term lettings in holiday destinations have higher yields or you could choose a property where the tenant’s lease is coming to an end.

4. Diversifying the portfolio

Location is a key risk because the country you choose will define the safety and profitability of your investment. However it’s not easy to build or manage a portfolio with different assets in different countries. There are different legal and taxation systems to deal as well as different contractors to manage the asset. Nevertheless, it’s still best to invest in two different countries or two different asset classes in one or two countries. For instance, Russian citizens often live in their Russian property and buy income-generating real estate abroad.

Choose a country with a reliable political system and a strong economy like Austria, the UK, Germany, the USA and France. For example, property in London and German cities gained 26% between 2010 and 2015 and is still expected to rise. To mitigate the risks linked to European property, you should consider investing some funds in financial instruments like securities from firms outside the Eurozone rather than looking for more property on the other continents.

5. Yields

Depending on the risk tolerance, the yield spread should be sufficient under current conditions. Later on, the risk profile can be adjusted and the appropriate investment decisions can be made if necessary. Standard commercial lettings yields in Europe are 5–6% per annum and residential property is only 4%, so if anyone promises you high yields, check out my other article to see why guaranteed yields don’t exist.

6. Financing

Taking out a loan will give you leverage to increase the yield. Portfolio investments, unlike single purchases, get better terms on credit that increase yields. In Germany, you can get a loan of up to 60% of the property value at 2% per annum if you are investing in real estate. So if the average rental yield is 6.5%, the investment yield in view of the loan could be up to 8–10%. If the portfolio is not refinanced, liquidity can be quickly achieved without selling it by increasing the level of leverage. At the same time, banks will allow you to finance other investments on the back of your current assets.

7. Management

While it’s possible to build, manage and sell the portfolio independently but when you are investing abroad, it’s often better to hire a company specialised in managing property investments as it saves time. As for your future tenants, quality tenants will minimise turnover and simplify property management.

8. Exit strategy and deadlines

There are two exit strategies: sell it or transfer by inheritance.

— Inheritance: the portfolio grows in value over time, though moderately, and can be owned by a single family for more than 100 years. For that reason, you should make arrangements to transfer it with minimal tax expenses.

— Sale: if you need funds urgently (e.g., for your main business), choose a liquid asset that can be sold quickly (2–4 months) without a significant depreciation. The best way to achieve this is to buy property in prime locations or multipurpose real estate.

However, if your goal is to build a personal wealth fund, you are probably not planning on making a rapid exit (excluding force majeure). This kind of portfolio requires long-term thinking and an investment strategy for at least the next fifteen years as well as strong knowledge of the tax systems and potential risks. If you have any questions regarding the specifics of real estate investments, I’m happy to help. You can contact me on on LinkedIn or Twitter.

George Kachmazov, Tranio