The entire developed world is troubled by the question of placing short-term funds due to high inflation and zero interest rates in bank accounts. It concerns funds that will be needed in a few months, possibly within two or three years. Households do not want to take risks with these resources, as they usually have a specific usage target.

However, they know that if they let them just lie idle in the account without working on themselves, they will lose value due to inflation.

Yes, inflation is becoming a big scarecrow in the post-pandemic age. Although it has never disappeared historically, it has not been a significant problem in the past decade. At present, however, we are witnessing a sharp rise in the prices of almost all goods and services.

Basic Parameters of the Intelligent Wallet

The Intelligent Wallet is precisely the product that addresses the problem of short-term savings. After months of analyses and testing of various portfolios and combinations of different asset classes, a product with the following parameters has seen the light of day:

• targeted yield of 2 to 3% annually,
• minimum possible risk (annual volatility 3.7%),
• stable growth with minimal fluctuations (95% probability of a maximum decrease of up to 5%),
• portfolio management fee of 0,5% p.a. including VAT
• no fees for entry, payment processing or for investment advice,

To sum it up, the goal of the product is to achieve a return at the level of inflation with minimal risk and fee.

Note: All data related to the historical development of Finax portfolios are modeled and were created based on backtesting of the data. We described the method of historical performance modeling in the article How do we model the historical development of Finax portfolios. Past performance is no guarantee of future returns and your investment may result in a loss as well. Inform yourself about the risks you are taking when investing.

How the product was formed and what the journey showed us

It is impossible to obtain a return completely without risk at the present age of zero interest rates. This fact is well known to everyone. Financiers are not magicians and investors can only work with tools and conditions that are available on the market.

If one wants to achieve a return at the level of inflation today, a certain degree of risk cannot be avoided. They must inherently reach for investment instruments, as banking products are unable to offer the desired return. The aim should therefore be to find a solution that minimizes the risk incurred as much as possible with an expected return of 2 to 3%.

We also proceeded in this spirit. We were looking for a combination of investment instruments that would be able to provide the required return in the medium term and the undertaken risk would be low and acceptable for conservative investment profiles.

We chose from the instruments traded on the stock exchange so that clients could also take advantage of the tax exemption. In addition to all sorts of bond classes (government, corporate, high-yield, inflation-protected, etc.) and equities, we also looked at real estate and commodities.

The algorithms created by us have gone through thousands of combinations and ratios of individual components so that we could look at the reverse models and determine which portfolio best meets the criteria in the long run. We were looking for the right ratio of instruments with low cross-correlation, which would reduce the volatility (unsteadiness) of the portfolio as much as possible and achieve the desired returns exceeding 2%.

Why exactly 2%? The average growth of consumer prices (i.e. inflation) in Slovakia has reached 2.05% annually since 2005. That means you need to earn at least 2% p.a. to maintain the purchasing power of your money otherwise you will be able to buy fewer and fewer goods or services for your hard-earned money every year.

The results were really interesting and revealed a lot. In the first place, they clearly confirmed the positive relationship between return and risk. The portfolios achieved higher performance only at the cost of greater risk, ie. their value either fluctuated more or their maximum decline was higher.

Another interesting fact that came out of the testing was the denial of the usual investment thesis that wider diversification between different asset classes will improve the risk-return parameters of the investment. The inclusion of real estate and commodities in the portfolios did not yield positive results. It did not increase the return at the same risk as the equity-bond portfolio or did not achieve the same return at a lower risk.

The testing of the Wallet also showed that, in the medium and long term, the combination of the two basic asset classes of equities and bonds remains unsurpassed. Extensive analysis has confirmed that the composition of the Intelligent Investing portfolios is set up correctly and a more meaningful and effective investment for long-term wealth building cannot be currently found.

Composition and Performance of the Intelligent Wallet

As a result of back-testing thousands of portfolios with different asset classes, we have reached the following composition of the Smart Wallet portfolio.

Each component plays a certain role in the portfolio. The individual asset classes are not correlated with each other much - their development over time is not identical. As one part of the portfolio declines in value, another grows. Together they form an ideal combination according to the achieved return and portfolio volatility.

Equities, gold, and inflation-protected bonds secure the portfolio in times of rising prices and increasing interest rates. Bonds and cash, on the other hand, represent a stabilizing component for periods of adverse economic development, economic and market contractions.

The reasons for the unusual presence of cash in the portfolio are explained in the next part of the article.

In accordance with the philosophy of passive investment, we also apply rebalancing to the Wallet portfolio. However, we slightly adjusted the maintenance of portfolio riskiness for the short-term product. The method of the Wallet rebalancing differs from the method of managing the basic Intelligent Investing portfolios.

The historical development of the Intelligent Wallet was modeled from the beginning of 2000. Longer testing was not possible due to the lack of relevant data on the underlying asset classes.

The historical returns of the Intelligent Wallet document the fulfillment of the investment goal of this short-term product. In almost all periods, the performance of the portfolio exceeds the set inflation target of 2% in line with its development over the past 15 years.

It is worth realizing that the Wallet is an investment solution based on liquid market instruments and not a deposit product in a bank or a fixed-rate instrument. Its value naturally fluctuates over time, as shown in the graph of its 15-year modeled development at the beginning of the article.

We tried to eliminate fluctuations as much as possible by the portfolio setting. With a 95% probability, the maximum declines in extreme market situations will not exceed 5%. Likewise, not every 1-year horizon ends in profit. In the past 20 years, there have also been 3-year periods that have not ended in green numbers. If you want to place your funds in the short term and you can handle investment fluctuations of up to 5%, the Intelligent Wallet is the ideal place for your money.

However, every short-term investor in the Wallet must also count with slight fluctuations in its value. As the saying goes, you don’t work, you don’t eat, and there is no return without taking risks. However, the reward for the risk was a very nice average 1-year return of 2.30% to 2.85% on all the examined 1-year periods for the last 10, 15, and 20 years.

Why is There Cash in the Wallet?

You may have been disappointed by the fact that part of the resources in the Investment Wallet is held as cash. Today it is primarily an element that stabilizes portfolio volatility for us. Testing different combinations of the composition of the Wallet showed that portfolios without cash or with its low weight achieved worse risk indicators.

However, many of you are justifiably asking why should you pay a fee for holding cash in Finax. The question has two answers. First, to make the service simple, we decided to apply a lower fee to the entire portfolio rather than a higher fee only to the invested part of the portfolio.

We plan to further improve the above-stated parameters of return and risk by including a fixed-income instrument in the Wallet portfolio. The development of the Wallet is not over.

In a short time, we want to bring to the market a solution and tool that could yield a 1% annual fixed return, and we will probably adjust the overall composition of the portfolio as well.

For the time being, we will not overtake and reveal our thoughts, but in principle, it should be an unrivaled debt instrument covered by highly liquid traded assets. From the point of view of credit quality and security, the offered yield will be very attractive.

Replacing cash with this instrument would increase the average annual return of the portfolio over the past 20 years by 0.35 percentage points per year while maintaining the current composition (cash replaced by an interest-bearing instrument).

Volatility would also slightly decrease and the maximum decline would be reduced by 0.7 percentage points over this period. The risk-weighted return measured by the Sharpe ratio would increase by a decent 17% compared to the current portfolio.

We believe that at the beginning of the next year, we will be able to deliver the planned project and adjust the composition of the Wallet. The solution in preparation would significantly increase the resilience of the short-term product to potential inflation shocks and a possible sharper increase in rates.

We also want to work on more flexible use of the Wallet in the future, e.g. for transferring funds to other accounts, etc.

The Intelligent Wallet offers a solution for short-term savings with a horizon of 1 to 5 years. Its goal is to beat inflation with minimal risk of average volatility of up to 5% with its yields, ie. to achieve an average appreciation of 2 to 3% per year.

The composition of the portfolio, based on back-testing, best meets the set parameters. The historical performance of the investment with this composition exceeded the set return target with acceptable risk for most of the monitored periods. However, it should be borne in mind that past returns are not a guarantee of future returns.

Finax no longer offers only solutions for medium- and long-term savings investment and wealth-building, but also for short-term reserves and expenses. The Intelligent Wallet is another product of the expansion of our financial services with the aim of offering the Central Europeans comprehensive personal finance care services under one roof.