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BUILDING AN INVESTMENT PORTFOLIO

Different types of assets such as shares or bonds behave in different ways, and the first step in forming an investment strategy is to achieve the right balance between major asset classes to satisfy the degree of risk you are prepared to take. This asset allocation can be fundamental in achieving your investment goals in the medium to long term.

THE MAIN ASSET CLASSES

The main types of asset are indicated below, and investing across a range of these classes provides diversification:-

  • Cash: bank deposits - very low risk, modest returns normally.
  • Fixed Interest: this includes broadly gilts and corporate bonds (see tabs under Investment). Generally low risk compared to shares and normally a low correlation with how shares perform.
  • Property: enjoys relatively low volatility and stable long term returns normally. A good diversifier against other asset classes but may be illiquid.
  • Shares: historically provide higher returns but are more volatile over shorter terms with increased risk. This asset class would include equities in UK, US, Europe, Far East, Emerging Markets, Specialist areas.

USING AN INVESTMENT MODEL

 An investment model can sometimes be employed to gauge how investment returns on different asset classes may vary over time. This can help to calculate the effect of different investment strategies to suit your attitude to risk and long term aims.

Modern Portfolio Theory can be employed to try to demonstrate an "efficient" investment portfolio than can deliver the maximum return for any given level of risk. This is known as optimised asset allocation or the "efficient frontier". A fundamental principle of Modern Portfolio Theory is that risk be considered as a whole rather than the individual assets in isolation. To achieve balance, you need to include assets which have no correlation or negative correlation to each other, so that if one asset class is under-performing, another asset class is hopefully increasing in value. This is the important principle of diversification.

ASSESSING YOUR RISK TOLERANCE

Risk comes in many guises but the main concept of risk is probably well known. The price of a very low risk investment is usually a very modest return, and if you want higher returns you may have to take some chances. The difficulty here is the effective measurement of the level of risk you are prepared to take, can take, or are comfortable with. This process can involve some detailed questions where we try to assess the following factors:-

Your Financial Circumstances

  • Investment term
  • Level of cash reserves to meet unexpected expenses
  • Your future potential earnings or income
  • Size of your investment portfolio
  • Your debt position
  • Your retirement Provision

Your Tolerance To Risk

  • Your overall view on investing
  • The importance of avoiding short term losses
  • The level of loss that would concern you
  • Your view on whether any notional losses can be recovered
  • The importance of inflation protection
  • The extent to which you are prepared to assume higher risk to achieve higher returns

 SUMMARY

Constructing an investment portfolio involves a number of actions:-

  1. Assessing the degree of risk you are prepared to take or can take.
  2. This degree of risk should provide an optimised asset allocation.
  3. Within the asset allocation, select funds or investments which satisfy certain criteria (eg consistency of performance).
  4. Consider short term variations from the model according to current market conditions.
  5. Review the portfolio regularly.

Contact us for more details of assessing risk and building an investment portfolio.

Free Consultation

You can have a free initial consultation. There's no fee, no catch and no obligation on your part. 

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