If you read the financial press or browse through investment forums and social media, you will see a lot of speculation about the latest stock tips and speculations about what you can, or should, be investing in.
However, focusing on individual companies and microtrends can lead to missing the bigger picture. A single stock is rarely the key to achieving your investment goals. There is significant risk in concentrating your investments in one place, as you will be disproportionately exposed to the risks of that company or sector, this may even result in you losing money. It is far more valuable to think of your investments as one collective unit. The holdings within your portfolio should be considered based on their own merits, but also on how they complement each other.
Below are some helpful guidelines to help towards building a healthy portfolio from outset, regardless of its size.
Holds a wide range of assets
The main asset classes are:
- Equities (shares) – highest risk, greatest return potential
- Fixed interest securities (bonds)
- Cash – lowest risk, lowest return potential
These assets bring different levels of risk and reward. Equities carry the most risk and volatility, however, they can produce the greatest returns over the longer term. Cash is stable with little volatility but is unlikely to generate high returns and is at risk of its value being eroded by inflation. Property and fixed interest fall somewhere in between on both prospect of growth as well as volatility.
Within each asset classes, there is also degree of variation. Equities can comprise anything from well-known UK companies to start-ups in emerging economies. Clearly, these companies will have a very different risk and reward profile and will not necessarily be correlated with each other.
The key to successful investing is holding a wide enough range of assets. There is usually very little correlation, and in some cases a negative correlation, between different asset classes which helps to minimise risk. It also allows you to capture market growth regardless of what is happening in the market.
Balance risk and reward
We cannot have a ‘one size fits all’ when it comes to investing. A portfolio which holds more in equities than lower risk assets will always experience more volatility. It is also more likely to produce higher returns if held for a long enough period of time.
When it comes to deciding the asset allocation for your portfolio, you will need to consider:
- Your attitude to risk and capacity for loss
- How well you understand investments, and your level of confidence.
- The level of growth you are seeking.
- How long you are looking to invest for and when you are likely to need the money.
A healthy portfolio aims to maximise returns, while balancing the level of risk you are willing to take.
Prioritise your goals, not the benchmark
Benchmarking is used to measure the performance of a particular sector or a selection of funds. By comparing a prospective fund against the benchmark, you can assess how it is performing alongside its peers. This can be useful when selecting funds in particular sectors.
But benchmarks are often of limited use when evaluating the performance of your portfolio. This is because, sector benchmarks are made up of hundreds of different funds many of which will not be appropriate or relevant for you.
If you are on track towards achieving your goals and are achieving steady returns, does it really matter how the benchmark is performing?
Keeps costs under control
While we cannot predict how investments will perform, costs are a certainty. If two funds invest in the same assets, but one charges 0.5% and the other charges 1.5%, the second fund will always underperform.
Over a 30-year investment term, this additional 1% in charges could reduce your eventual pot by around 25%.
While costs should not be the only consideration, seeking value for money should always be a goal.
Hold for the long term
A diverse portfolio of funds over a long term, will generally see an increase in value.
It will fluctuate, and it is not unusual to lose money at first. But it is vital that you keep your discipline and avoid the temptation to sell whenever market fluctuations make you nervous. You need to consider that single events can affect the performance of a fund. They can distort the true reflection of a fund’s long-term growth potential and current holdings.
Taking money out of the market at a low point turns a theoretical fluctuation into an actual loss. Even if you reinvest when the market starts to recover, it is likely that you will be worse off over the long term, particularly if the pattern is repeated.
Drops in the market are usually followed by a recovery. It is impossible to predict when the lowest point is reached, when the bounce back will occur, or how long it will take. Generally, an investment term of at least five to ten years will smooth out these bumps. Holding for longer timeframes is preferable to allow your portfolio to reach its full potential and means that you can afford to take greater risks.
These principles can be applied whether you are investing a first-time investor or you have already built up a substantial pot. The investment choices available today mean that your portfolio can be scaled and adapted as your wealth grows.
Please do not hesitate to contact a member of the team to find out more about your investment options.