Everlake Guide to Investing in Ireland

Introduction

Investing is a very personal decision. Some of us are very comfortable talking about money and investing. For others the world of equities and bonds is very distant from our everyday lives. It is something that we hear in the business news and often that news is portrayed as being bad for investors and this makes us anxious. It can be difficult to know what to do.

In this guide we set out the key issues that we believe you need to consider in putting an Investment Plan in place. The key to a successful investment experience is to have clearly thought through what is important to you and what you want to achieve, and then document it as your plan.

We normally recommend that you undertake a full financial planning process (focusing on protecting your family, paying down debt, planning for retirement and tax and estate planning) before putting in place your Investment Plan. Full consideration of your financial needs and goals can have major implications for your investment planning. For further details on our Financial Planning services see our guide.

Before designing an Investment Plan for you, we recommend that you complete a full analysis and review of your existing and likely future circumstances. You may be a professional, a senior executive, or participate in a family business, or you may be internationally mobile with interests outside Ireland.

Whatever your circumstances you will have unique challenges and opportunities. Over the years you will have entered-into financial arrangements for what were probably good reasons at the time. With the passage of time and change in your circumstances and the tax and regulatory environment your existing portfolio of assets may not be optimal now.

There may be opportunities to restructure your personal or business assets to avail of favourable tax reliefs. We will always take the time necessary to review your existing circumstances and make specific recommendations in respect of your existing assets and liabilities. As fee-based advisers, we conduct this analysis free from the conflict of interest associated with an adviser who is only remunerated if they sell you a new product.

As we look to the future you may wish to consider new issues such as life and legacy planning. You may have children progressing through education or starting their career. We always take to time to consider the best way of deploying your assets with legacy planning in mind. We can facilitate a range of planning structures including loans, partnerships, trusts and corporate structures that may assist you to support your family as they progress through life

Finally, bear in mind that, relative to other countries, the Irish tax and investment landscape is relatively complex. Books and websites in, for example, the USA and UK don’t necessarily translate well for an Irish Investor.

We will help you to understand these issues and to articulate them by working through each of the steps you need to consider as laid out in this guide. Only when we have worked through and documented your preferences and understood your values and motivations for investing will we move to implementation.

Once your Investment Plan has been put in place it is important to keep it under regular review. Many things can change over the course a year. Your personal circumstances, other external circumstances such as tax and regulatory issues or the performance of the markets may all impact on your plan.

Rather than look to an arbitrary external market index such as the S&P 500, we use your financial plan as a personal benchmark against which to assess if you are on track with your objectives.

We monitor and update your plan as necessary on an ongoing basis to give you the best chance of achieving all that is important to you.

We hope that you find this guide useful. Please contact us if you want to discuss any aspect in greater detail or if we can assist you with your financial planning or investment needs.

Our Approach To Working With You

Before embarking on your Investment Plan we will review the following with you:

1. Assess your current assets and liabilities. This involves listing all your assets and loans by reference to valuation, ownership structure, domicile (where they are physically) and tax status. Key assets and liabilities will typically include:

• Private Residence

• Private Motors

• Cash Savings

• Family Business

• Restricted Stock

• Investment Properties

• Investment Funds

• Equities

• Bonds

• Pension(s)

• Mortgages & personal loans

• Life Assurance & Protection Policies

We will assess these assets to understand the allocation between different asset classes and to establish the overall risk profile of your assets. This will be an important consideration when we move on to consider the asset allocation under your investment plan.

2. Discuss recommendations for optimisation. There may be opportunities to restructure your current portfolio that make sense before you embark on designing your investment plan. Typical opportunities might include:

• Realising certain capital gains and losses which may be offset against each other.

• Taking advantage of tax planning opportunities such as pension contributions

• Reducing debt

• Consolidation of investment assets to simplify administration or for Estate Planning

3. Consider planning opportunities. As you focus on the future there may be a range of solutions that you could put in place. Some examples include:

• Wills & Powers of Attorney o Appropriate provision for foreign assets

• Legacy Planning o Structured Loans o Family Partnerships

• Business Succession o Maximising Entrepreneurial Relief for all family members o Ensuring shares are structured to avail of Retirement Relief o Passing on a participation in the business to children and family members in a tax efficient way o Key-person insurance

Developing Your Investment Plan

Once all the topics arising from the review above are completed, we can move on to consideration of how to make best use of your investable assets. Our investing process centres around six steps:

1. Assess your investment goals and personal values. The investment plan process begins during a Discovery Meeting with a discussion of your financial values and goals, as well as your key relationships, existing assets, other professional advisers, preferred process, and important interests.

2. Set long-term investment objectives. Taking into account the long-term nature of successful investing, we help you set objectives for your portfolio that are appropriate for your willingness, ability and need to take risk, and the investment horizon(s) you identify.

3. Optimise Tax Structures. The tax treatment of your investments will be dependent upon their legal form. For example, pension assets are not taxable within a pension structure but are potentially taxable on withdrawal (often at a lower marginal rate).

Investment assets may be subject to either Exit Tax at a flat rate of 41% on income and gains with no reliefs or exemptions (most funds) or general tax principles of income and capital gains tax (certain forms of securities).

4. Plan your asset allocation. Asset allocation, the mix of investments in your portfolio between lower risk defensive assets such as cash and bonds and riskier growth assets such as Equities and Real Estate is generally accepted by academics objectively studying the subject as more important than either trying to time when to buy or sell (market timing) and trying to pick winning securities (stock picking) collectively known as active management.

During the asset allocation process, we set out how much of your portfolio to invest in each of the different investment types, or asset classes, including stocks, bonds and real estate in order to meet the expected return you need to achieve your investing objectives

5. Select your investment approach. With an asset allocation in place, we now turn our attention to how you might best achieve a successful investment experience. Unlike many of our competitors, we don’t believe that there is a “magic sauce” which can do this but rather that two key investing principles should guide how you approach investing: the importance of diversification and the benefit of staying invested in the markets.

6. Build your portfolio. Building on the first five steps, we construct a portfolio which is customised and best suited to your needs, goals, time horizon, risk capacity and significantly your personal values about investment considerations such as taxation, cost and sustainable investing considerations

The building blocks in our client’s portfolios are generally best in class global investment funds from leading managers such as Vanguard, Blackrock and Dimensional Fund advisers who collectively manage over $16 Trillion as at the end of June 2022.

1. Assess Your Investment Goals and Personal Values

Long-term investment success means different things to different people. The best investment plan for you depends on your specific circumstances and objectives. That is why we begin the investment planning process with a discussion during our Discovery Meeting of your values, goals, relationships, assets, advisers, preferred process and interests.

Your investment plan is only one part of your overall financial plan. You may wish to consider your wider financial goals and objectives as you put your investment plan in place.

While everyone’s situation is unique, certain factors matter in creating any investment plan. These factors include the purpose of the investment, its size, the sources and planned uses of the funds, and the amount of uncertainty you are comfortable having. By thinking clearly about your goals and circumstances, you build the foundation of an investment plan that best matches your needs and the realities of the financial markets.

We always seek to ensure that your values are reflected as fully as possible in the financial planning and investment approach that we recommend.

For example, we ask you to articulate your interest in Sustainable Investing, the umbrella term for investing that explicitly considers ESG factors (Environmental, Social and Governance), that aims to achieve a sustainability outcome and/or reflect a particular set of values or beliefs.

But what does Sustainable Investment really mean? Is it for you or are you more interested in Social Impact investing and Philanthropy? And, if it is, how do you go about choosing socially responsible and/or sustainable investments?

Our Consultative client process is designed to uncover your true intent about your money. If aligning your investment strategy and values about society and the environment are important to you, then we offer portfolios that will help you to meet this specific investment objective. However, in this guide we are not going to try to convince you that any one investment strategy or approach is better or worse than any other. As Financial Planners, it is our belief that the only perspective that really matters is this; the way in which you invest your money should reflect your personal and deeply felt values and beliefs.

Details of the full Investment Spectrum is included in Appendix 1.

2. Set Your Long-Term Investment Objectives

Most investors know they should focus on the long-term. This often gives rise to the question “How long is long term?” The answer for many investors is surprising your long-term horizon should be as far into the future as possible and therefore, ideally, inter-generational

One of the many surprising facts about investing is that having a long horizon is a powerful advantage. You want your horizon to be as long as possible, because as an investor, time is your ally.

For many investors, the most important long-term goal is to make work optional in order to be able to do what they want. But many investors also have intermediate-term goals funding college educations for their children, buying holiday homes or even founding charitable foundations are three examples. Investors may also have goals that reach far into the future for example, they may wish to leave legacies to their children, grandchildren and even great-grandchildren.

Regardless of the time horizon of your goals, the simple fact remains that the more time you have, the more likely you are to succeed as an investor. Why? There are two reasons. The first is the miracle of compound interest, and the second is the phenomenon of reversion to the mean

The Miracle of Compound Interest

Compound interest operates on a very simple principle. When you put money aside to earn returns, and then reinvest those returns, you have both your original investment and the returns working for you. The longer you allow this process to continue, the greater your accumulation will likely be. Imagine putting €1 million into an investment that consistently earns 8 percent every year. The table below shows how the compounding process works.1

At 8 percent, your investment would grow to more than 4½ times its original size in 20 years. To see the effect of compounding, notice that you would earn €1,158,925 in returns in the first ten years, but even more in the second ten years - €2,502,032.

While many people are familiar with the concept of compound returns, they may not be so strongly aware that time actually also helps reduce investment risk, especially in a diversified portfolio of stocks. It is natural to worry that if you invest in the stock market today, it may go down tomorrow. But if you have a long investment horizon, tomorrow is just one of the thousands of market days during which you will be investing. Over long periods of time, many of the ups and downs in the market are cancelled out, leaving you with the broad market trend return.

1 Figures are for illustrative purposes only and are not a guarantee of future performance. Figures do not reflect the effect of fees or taxes.

Stocks For The Long Run

The following graph shows how the range of annualized outcomes for the U.S. Stock market as measured by the S&P 500 narrows as your time horizon becomes longer. It shows results based on the performance of Standard & Poor’s 50 Index from 1926 to 2018 2 Although the average annual return has remained relatively constant at around 10% pa, the market has produced a wide range of outcomes around this average. An investor holding stocks for just one calendar year could have had returns ranging from a positive 162.88% percent to a negative -67.57 percent. An investor with a tenyear horizon could have experienced annualized returns ranging from a high of 21.43 percent to a low of -4.95 percent

However, investors who were invested for 20 years, had all 20-year time periods with positive returns.

Standard & Poor’s 500 Index Overlapping Returns Annualized

Annual: 1926–2018

We thus see the importance of simply investing for the long term, regardless of when you buy. This is true because an investment plan’s success cannot be fully realized until the underlying portfolio has gone through the various economic and market cycles that will be experienced over a long period, such as ten years.

What Do We Mean By Investment Risk?

In simple terms, risk is the possibility of something bad happening.

Before putting in place a long-term investment plan it is critically important to understand the risks associated with investing. Investment risk can be considered in several different ways. There is the risk of the permanent loss of capital either through an investment collapsing in value with no possibility of recovery, like Anglo Irish Bank, or the constant grinding erosion of value over time from inflation.

This is different to volatility. Volatility is when the value of your portfolio fluctuates from day to day and is analogous to turbulence on a flight, it makes us feel uneasy, but it won’t cause a crash.

It is crucial that you consider all the dimensions of risk.

These include:

• Your attitude to investment risk or risk tolerance this is very personal to you and may influence your response to market fluctuations or volatility

• Risk capacity: Your ability to suffer losses without materially impacting your ability to do the things that are important to you. This is more of an objective assessment and in planning terms is the most important consideration

• Risk avoidance: Do you even need to take investment risk? Maybe paying off debts or arranging insurance could be a better strategy

• Your tolerance for tracking error: your ability to have your portfolio look different from popular market indices. This relates back to the idea that the best portfolio for you might not look like anyone you know

• Your rate of return objective. This is the return your portfolio needs to achieve on average and meet the objectives set out in your plan. It isn’t the “best return possible at all costs” it’s the return you need to meet your goals.

We will take time to explore your capacity for risk. See Appendix 2 Risk Considerations for further details.

Behavioural Biases

Another concept to consider is the field of behavioural finance which attempts to identify the systematic errors and biases which recur predictably in certain circumstances, offering a framework for understanding when and how people make mistakes.

Often, our emotions prevent us from holding an optimum portfolio that will allow us to achieve the returns we need since we have certain in-built biases which prevent us from objectively constructing our portfolios. We suffer from overconfidence in our abilities as investors. We suffer from regret about decisions made in the past. We extrapolate random patterns into the future. We suffer from hindsight bias (past events now seem obvious) and we are loss averse so that we emotionally weight the benefit of gains less than the hurt of losses.

From an investment perspective, an important aspect of avoiding such biases is first to become aware of them. Thus, by avoiding behavioural biases investors can more readily reach impartial decisions based on available data and logical processes. This requires understanding one’s behavioural biases, resisting the tendency to engage in such behaviours, and developing and following objectively prudent investment strategies. See Appendix 6 Behavioural Finance for more on this

3. Optimise Tax Structures

Because investors spend after tax returns, before we determine your preferred asset allocation, we will consider the best way to implement that allocation by reference to the legal structures available and the tax treatment of the various investment instruments. The tax implications of the various options are as follows:

1. Pensions

Pensions are one of the most valuable planning options available to investors in Ireland. Tax relief is available on contributions against earned income and all income and gains within the pension are exempt from Irish Tax. When the funds are drawn down, they will be subject to income tax but often at a lower marginal rate than when working.

This offers an opportunity to grow assets tax efficiently and free from the tax complexities of personally held assets. Currently up to €2million can be accumulated tax efficiently per investor in an Irish Pension. In practice this may only be possible through certain company structures as the annual contribution payable by an individual is subject to restricted limits.

2. Equities & Bonds (Directly Held)

Marketable securities (typically equities and bonds) are subject to normal income tax and CGT rules. Dividends and interest are subject to income tax, PRSI etc and capital gains are subject to CGT. This allows for a certain amount of flexibility as to when you realise gains are losses. This allows you to match gains and losses in a particular tax period. Losses can also be carried forward to offset against future gains. CGT can also be offset against CAT on certain gifts.

3. Investment Funds (Directly Held)

Investment funds come in various legal form. Most funds available to investors in Ireland will be constituted as a UCITS fund3. These funds and similar offshore funds are subject to an Exit Tax regime. The tax treatment of directly held marketable securities and Investment Funds is explored further in Appendix 3 Tax Considerations

4. Family Partnership

A Family Partnership is an effective Estate Planning option as the income and gains will generally be assessable against adult children rather than their parents effectively passing on growth to the next generation. In the case of minor children who are partners Income Tax will be payable by the parents, but CGT will be payable by the children directly.

5. Corporate Structures

Marketable Securities and Investment Funds held within corporate structures are generally subject to an onerous tax treatment and should be avoided or minimised.

3 UCITS – Undertakings for Collective Investment Transferable Securities. This refers to a regulatory framework that allows for the sale of cross-Europe mutual funds.

6. Charitable giving and philanthropy

Finally, there may be some tax advantages associated with making gifts to Charities

4. Plan Your Asset Allocation

Once we have worked with you to determine your time horizon, ability to take investment risk and satisfied you with a feasible rate-of-return objective that will meet your goals, we can begin the task of building your investment portfolio. The first step in this process is asset allocation.

The Importance Of Asset Allocation

Asset allocation is the process of deciding how much of your portfolio to invest in each of the different investment types, or asset classes equities, bonds and short-term investments as well as “real assets” such as real estate or commodities (See Appendix 5 Modern Portfolio Theory)

To investigate how important asset allocation really is, three leading investment experts (Brinson, Hood and Beeblower) performed a comprehensive statistical study to measure the importance of various factors in determining a portfolio’s performance. They studied the results of 91 major corporate pension plans over a ten-year period which included both good and bad markets. Their conclusion was that, on average, 94 percent of the variability in returns could be explained by the plans’ long-term asset class policy (see chart below). The remainder was attributable to individual security selection (4 percent) and market timing (2 percent).4 However, even though security selection and market timing explained 6 percent of the variability of returns, the overall contribution to performance was negative. The average plan lost 0.66 per year from market timing decisions and another 0.36 percent from security selection.

The authors conclude: “Because of its relative importance, investment policy should be addressed carefully andsystematically byinvestors.”

Determinants of Investment Portfolio Performance

Asset Classes (Equities vs. Fixed Income)

The main asset classes are outlined in Appendix 4 Asset Classes. The most basic asset allocation choice is between equities and fixed-income investments (also known as bonds). Equities represent participation in the long-term growth of companies and of the economy as a whole, while fixedincome investments (bonds) represent fixed obligations of governments and corporations. It seems natural, then, that equities should offer superior long-term growth potential, while fixed-income investments offer more stability. The choice of allocation between equities and fixed income is a clear example of the basic investment trade-off between risk and return.

In exploring asset classes, we begin with the historical performance of investment categories. This is not to say that the past guarantees future performance; however, it does indicate reasonable relationships between various asset classes. By referring to the graph below, you can see that historically, equities have far outperformed fixed-income securities. For example, one dollar invested in equities (as represented by the S&P 500 Index) at the beginning of 1926 would have been worth $7,025 (assuming reinvestment of dividends) by the end of 2018, while an investment in small company stocks would have been worth $68,312. An investment of $1 in small-value stocks would have grown to a staggering $128,193.

By contrast, fixed-income investments, and cash, have trouble even keeping pace with inflation. That same dollar invested in 5-year U.S. government notes would have been worth $98.47. If invested in 30-day U.S. Treasury Bills, this dollar would have been worth $21.17. Simply to maintain purchasing power (to stay even with inflation) an investor over this period would have required an increase in value to $14.04.5

Source Dimensional Fund Advisers

5. Select Your Investment Approach

As noted previously, the most important factor determining your investment outcome will be your asset allocation. Once you have determined your asset allocation, the next step is to consider your investment approach.

Most of the money around the world is managed by Wealth Managers and Investment Managers who subscribe to an “active management” approach. Their glossy brochures will focus on the ways in which they will help their clients to “beat the market”.

An investor could have beaten the S&P 500 between 1926 and 2018 which averaged 9.88%pa simply by taking a “Value investing” approach like that taken by Warren Buffet which averaged 11.09% pa. Or by investing in riskier smaller companies 11.96% pa or by investing in both small and value companies which over this period averaged 13.12% pa.

Growth of $1 between 1926 and 2018

Cash (one month Treasury Bills)

Whilst the research indicates that these dimensions of the stock market represent reliable sources of investment risk in global capital markets there is still no guarantee that investors who follow these strategies will profit from them. That is, after all, the nature of risk.

Unlike many, if not most, of our competitors, we don’t believe that most investment professionals possess sufficient skill to consistently beat the market after costs. Equally, whilst it is relatively easy to identify people who may have beaten the market over a particular period, it is difficult to distinguish between luck and genuine skill and we don’t know of any reliable way of identifying those who might beat the market in advance.

“The idea that any single individual without extra information or extra market power can beat the market is extraordinarily unlikely. Yet the market is full of people who think they can do it and full of other people who believe them….Why do people believe they can do the impossible? And why do other people believethem?” - Daniel H Kahnemann, 2002 Nobel Laureate in Economics.

Instead, we prefer to take an evidence-based approach derived from academic research to identify reliable sources of risk in global capital markets.

This body of work is known as Modern Portfolio Theory (see Appendix 5) and two key investing principles that should guide how you approach investing are:

• the importance of diversification and,

• the benefit of staying invested in the markets

Diversify Globally

One reason why many investors are reluctant to invest much in the stock market is that they know many stories of companies and stocks that have suddenly fallen on hard times. Some investors imagine an investment in the stock market to be like that when a stock has gone very high, it may be just the time that it is about to fall sharply. The mistake they make when they think this way is that they forget that while a single stock may rise or fall dramatically, the movements of the overall market are relatively much more subdued. As an example, see the performance of Bank of Ireland compared to the MSCI World Index below:

Graph of Bank of Ireland compared to the MSCI World Index Feb 1987 to Dec 2011

MSCI data copyright MSCI 2010, all rights reserved. Bank of Ireland Source Bloomberg

Modern Portfolio Theory provides the reason. It explains that two effects govern the movements of every stock market and stock-specific events. It is primarily the stock-specific events that cause individual stocks to move up or down wildly relative to the overall market. (Appendix 5).

You may think that your best protection against stock-specific risk is to have portfolio managers that know all the companies in your portfolio well. The trouble is, the events that cause the most damage to stocks usually come as a complete surprise. A company may have a sudden product liability problem, or the chairman may die or come under a cloud. On the upside, the company may make a surprise new product announcement, or land a major contract. These events are often unanticipated, and so they cause price movements that not even the best portfolio managers can predict

In fact, Modern Portfolio Theory tells us that if the market can anticipate an event, then the effect of the event is already reflected in the stock’s current price to such an extent that no further profit from knowledge of the event should be possible.

If it is surprising that portfolio managers cannot anticipate a stock’s movement, then how can an investor protect a portfolio against them? The answer is simply through diversification. The stockspecific movements of individual stocks may not be predictable, but when considered over a diversified portfolio, they tend to cancel one another out.

Modern Portfolio Theory tells us that we can build diversified portfolios to greatly reduce stockspecific risk, but that market events, which affect all stocks, are not diversifiable. That is, even a diversified portfolio of stocks is subject to the overall movements of the market. Fortunately, the theory predicts that the market rewards us for taking this risk by giving us generous long-term growth potential. The asset allocation decision is where we decide how aggressively to pursue this long-term growth.

The key take home for investors is that you should expect some investments within your portfolio to be going down from time to time and some to be going up. If all of the investments in your portfolio are all going up at the same time, you cannot possibly be diversified. We like to use the analogy of a shop selling both sunglasses and umbrellas. It doesn’t matter that on rainy days’ people don’t want to buy sunglasses and vice versa.

Stay Invested

Investors often ask when is the right time to invest? For a long-term investor, the answer is today. There is no short-term investment opinion behind that statement. No one can predict the movements of the market for the next month or year.6 Just as with unanticipated events, if portfolio managers could somehow predict the future movement of the market, then prices in the market would already reflect that knowledge, and so it would be impossible to profit from it.

Even though there is always a danger that the market will go down tomorrow, today is the right day to start investing. The next chart shows why. A large proportion of the long-term gain in investment in the stock market comes from sharp upward bursts. Just missing a few of the best days would have resulted in dramatically lower returns than staying invested throughout the period. Smart investors stay invested for the long term.

6. Build Your Portfolio

For most people, building a truly diversified portfolio is difficult. Imagine that you wanted to build a diversified portfolio of 10,000 stocks worldwide. It is simply not cost effective for an individual investor to attempt to achieve this.

Equally, the lowest price investment funds available to institutional investors are beyond the reach of most individual investors.

Even if you have enough money to build a diversified portfolio, you may not have enough time. Choosing 10,000 stocks that you can buy with confidence is difficult enough. Once you had bought the stocks, you would still have a lot of work ahead of you. You would receive masses of information on many companies, and you would have to review your portfolio regularly to decide whether it still suits your objectives. It would be a lot of work to even calculate the performance of your portfolio and decide whether it was good or bad.

An easier way to implement a diversified portfolio is through investment funds used by large financial institutions rather than retail investment products. By buying an institutional asset class fund, in a single transaction you invest in a broad diversified portfolio in a specific asset class. These institutional asset class funds combine your investment with those of other investors to build up a pool of money large enough to buy a diversified portfolio. The portfolio manager’s full-time job is making sure that the securities in the portfolio continue to be suitable for the fund’s investment objective.

Asset Classes

Brief details of the main asset classes are included in Appendix 4. Our client’s portfolios are almost exclusively designed to incorporate the asset classes below

Cash

• Bank Deposits and State Savings

Bonds

• We generally favour Global Bonds Funds of high credit and short-term with currency risk hedged to Euros

Equities

• Developed Equities (e.g USA, Europe and the Far East)

• Emerging Market Equities (e.g . China, India etc)

Other Assets

• Global Real Estate Investment Trusts (REITs)

• Infrastructure funds focused on sustainable investing and renewable energy projects

Note that we do not advocate investing directly in residential or commercial property for our client’s investment portfolios. Being a landlord is a full-time job and there are easier, more flexible, and less risky ways of investing in Real Estate.