Investments
Help is at hand!
To the novice investor, the world of investments can seem a daunting place. Consulting an Independent Financial Adviser prior to making long-term investment decisions is therefore always a wise move.
The savings and investment market place stretches from basic deposit accounts, right through to sophisticated strategies involving both tax planning and succession planning. Faced with such a bewildering array of products, your independent financial adviser can be a great source of comfort in ensuring that you get all of the important decisions correct.
Each investor will invariably have different investment objectives and is likely to demonstrate a different appetite for investment risk. Investment decisions should never be based on emotion. Your adviser has therefore been provided with access to wealth of tools which have been designed to apply a more scientific process to ascertain your appetite for investment risk. A detailed questionnaire will need to be completed by you to pinpoint your attitude to investment risk prior to looking at any portfolio design. The questionnaire will provide a risk rating of between 1 and 10; 1 being risk averse. The risk rating will determine the balance between the various asset classes available. Few financial advisers drill down to this degree of risk assessment.
Risk is a necessary and constant feature of investing. Shares fall, economic conditions fluctuate and companies can occasionally go bankrupt. There are many different asset classes available to invest in, each possessing different risk characteristics. Whilst the risk attributable to asset class cannot be avoided, when they form part of a diversified portfolio and can be managed collectively, they can at least be diluted.
The key is not to put all of your eggs in one basket. Here lie the fundamentals of diversification; spreading an investment across a wide range of asset classes and sectors, thereby avoiding the risk that a portfolio will be overly reliant upon the performance of any one particular asset.
Asset Allocation
The best way to diversify investments is to spread risk and invest in several different asset classes. The principal choice is between shares, bonds, cash and property. The aim is to select asset classes that behave in different ways; the theory being that when one asset class is underperforming, the other is outperforming. For example, bonds and property often behave differently to equities, by offering lower, but more consistent returns. This provides a “safety net” by diversifying many of the risks associated with a reliance on one particular asset. Asset allocation rather than specific fund selection is responsible for over 90% of the expected return of an investment portfolio.
Share Specific Risk
The well documented demise of what was one of America’s biggest companies, Enron, has illustrated the dangers associated with investing in seemingly safe, large, multinational organisations. Whilst the impact would have been catastrophic to an individual with their life savings in the company, an investor holding Enron as part of a well diversified portfolio would have seen the effect considerably diluted. By investing in as few as 20 different stocks, the majority of share specific risk can be reduced.
Sector Exposure
Depending on what companies sell or produce, or what services they provide, they can be classified by sector. For example, BT resides in the Telecommunications Sector, whilst BP resides in the Oil & Gas Sector. Just as it is important to spread your investment across different companies, it is equally important to select companies from different sectors. For many reasons, companies within different sectors perform in very different ways. By diversifying across sectors and investor can access stocks with high growth expectations, without over exposing their portfolio as a whole to undue risk. Commodity or Technology shares are often seen as having high growth expectations, but stability can be achieved by holding stocks across sectors with lower growth expectations such as Pharmaceuticals or Insurance.
Geographical Location
It might feel better to invest most of your portfolio in your home market, but is it the most sensible option? According to the MSCI World Index, the USA makes up more than half of the world market. The UK only accounts for around 11% and Europe (excluding the UK) for some 20.5%. It has to make sense therefore to invest across a wide variety of global markets to dilute risk. Remember, no single investment house is able to provide well performing funds across all sectors, in fact few can boast well performing funds in more than one!
Fund Selection
There are literally hundreds and hundreds of funds available and no provider or fund manager is able to provide a comprehensive choice. In recent years, we have seen the emergence of fund supermarkets or platforms which offer the best selection within the market. The best way of ensuring sound return coupled with low volatility is to combine asset allocation with the best of funds available. Again, a scientific approach is used to determine the best funds; they are not selected based on pure performance. A number of filters are applied by us at firm level, including OBSR rating, Citywire rating, fund manager tenure and Alpha rating to name but a few. Should funds not continue to match the standard we set, they will be replaced. Our investment committee sits bi-annually to reassess our recommended funds in each sector.
Tax Wrappers
It is important that your financial adviser understands your tax position, because investments can give rise to taxation in different ways. As a rule of thumb, we would always recommend that investors maximise any tax concessions before considering investments that are taxed.
Emergency Funds
Prior to considering any investment, we would always advocate ensuring that our clients have sufficient fund to cover unexpected emergencies. Likewise, we would normally recommend that you pay off any debts before considering investing money.
Moving Forward – Rebalancing Investments
Many investors set up an investment portfolio, but their advisers fail to review it on a regular and ongoing basis. Having gone to great lengths to structure an investment to a given risk profile, what would happen if the equity content over performed and fixed interest under performed? At this point, equities would represent a lager share of the portfolio than they did at outset and fixed interest would then represent a lower proportion. Likewise, the recommended proportions to invest within each sector may have changed. It is therefore important that the portfolio is reviewed regularly to reflect any such changes.
It is further fair to suggest that an investor’s appetite for investment risk could change. If an investor retired for instance, it is sensible to suggest that he may wish to sacrifice growth for greater stability if he were seeking income from his investments. Reviews are therefore essential to the whole process of investing. Your adviser will discuss how we best we can achieve this with you and he will also you should agree the frequency with which you both review things.
Please note that past performance is not necessarily a guide to future performance and the value of investments may fall as well as rise.
