The following tips will provide you with a basis for building a successful investment portfolio.
The first thing to consider, be it investing in equities or mutual funds is, how much risk do you want to take? This is fundamental in deciding what investments to pick and ensure you are happy with the results, be it negative or positive.
Once you have established if you would like to go all out, or have a more cautious approach, then you then need to establish your time horizons and amount you wish to invest. Longer time horizon require a more measured approach and need take into account economic cycles.
Historically, generating good returns has been down to the asset allocation you hold. As many may know, economies go through cycles, boom -> bust -> recovery. Different asset classes perform well in different economic cycles. Establishing this is key to success.
There are a number of asset classes which you should consider:
- Equities
- Bond/Fixed Interest
- Property
- Commodities
- Alternative Investments
- Cash
For many this will make up the majority (if not all) of the portfolio. It provides a basis for capital growth within a portfolio. Equities since 1899 (discounting inflation) have returned around 24,000% compared to only 430% for bonds (Gilts).
Bonds/Fixed Interest
Generally, bonds and fixed interest provides a negatively correlated holding to equities within your portfolio. This allows the overall risk/volatility of the portfolio to be reduced protecting you during recessions (to a certain extent) and volatile markets. In addition, as bonds pay a regular coupon/yield it can also be a great source of income.
Property
Property is another high yielding asset which can provide significant capital upside over the long term. This is also a good asset to hold as again it can diversify your portfolio due to having little correlation with both equities and bonds.
Commodities
This asset class can play a varied role within a portfolio. Gold, one of the popular commodities with investors, has generated significant returns to investors over the last 5 years as people sought a safe haven asset. Gold acts quite like a currency and also will, to a degree, act as hedge against inflation.
Other commodity purchases such as oil, metals and softs are more specialised, taking a more fundamental view of long term pricing.
Alternative Investments
This is an area which has expanded dramatically in the last few years. Hedge funds were highly sought after pre credit crisis as they had the flexibility to produce excellent returns during trending markets. Nowadays, this area is dominated by absolute return funds, most notably is Standard Life’s Global Absolute Return fund, topping £20bn recently. They aim to achieve an absolute return during all market conditions with a target of LIBOR (or cash) + 4 to 6%. For many this is an attractive target. Downside is very limited as derivatives are combined with a multi strategy approach across all asset types to produce a very uncorrelated and diverse fund.
Cash
This asset class must not be forgotten, when interest rates were higher, cash provided an excellent source of secure income. As of late, many will see little reason to hold this as returns are next to nothing.
We have now established the core asset classes at your disposal. The more cautious investors will aim to combine a heavier weighting in Bonds/Fixed Interest and Alternative Investments with Equities, Property and Commodities having a smaller exposure.
One would generally associate a Cautious approach to hold anywhere between 20 and 60% in Equities, with the remainder spread across other assets, and an Aggressive investor up to 100%.
Once you have determined the proportion of each asset class you want to hold, selecting the individual markets, countries and sectors to invest in is the next stage.
Lets take your portfolios allocation to equities for example. A majority of the countries throughout the world have at least one equity market. The UK has the FTSE100 (and more), the U.S has the Dow Jones among many, Germany the DAX, and so on. You must establish which countries/economies you wish to invest in and why. It is important to consider all the following major markets, as they generally consist of the larger more successful companies; UK equities, U.S equities, European equities, Asia (ex Japan), Japan and Emerging Markets (this is comprised of such countries as Brazil, China, Russia and India). Having exposure to more than one market diversifies risk and takes advantages of the relative opportunities within that economy.
For bonds/fixed interest, you should consider investing in a mixture or one of Government bonds, Investment Grade corporates or High Yield. Then which country or region specifically.
After establishing the markets to invest in, selecting the individual investments is the next step. Time and knowledge play an important role in the selection process and many, myself included leave this down to the experts. Investment funds (OEICs, Unit Trusts and Investment Trusts), provide access to a range of securities leaving the stock picking and strategies to the pros. There are a wide range of unit trusts available and one must be diligent in picking the correct ones to ensure optimum returns.
Whilst I am not dismissing selecting your own equities, risk management and stock selection is a time consuming process, and to manage this across every asset class is a full time job. With such a large number of unit trusts available, you can almost always find one which targets your specified market and strategy.
So lets recap the process:
This should provide you with the basic building blocks for your portfolio. However, as knowledge and experience play such an important role, I would recommend seeking financial advice before proceeding with investing yourself as they will be able to ensure your investments are tailored to your needs.
For some ideas of what you can invest it, check out our Top 10 Funds of the Month.
(The investment selection process is extremely varied and those examples above are a small proportion of what is available).
If you have any queries please leave a comment.
No comments:
Post a Comment