When it comes to making financial plans for the future, a balanced investment portfolio can help. But what does this involve, and how can you make sure your portfolio is tailored to your own specific needs and goals?
- What is an investment portfolio?
- What is asset allocation?
- What are the main components of an investment portfolio?
- What are the main types of investment portfolios?
Your investment portfolio encompasses all the different types of investments you have.
Shares, cash, property and bonds – both corporate bonds and government bonds (gilts) – can be part of a portfolio, and the make-up of the portfolio can change over the years as your requirements and goals adapt.
There are various types of investment portfolio, including pensions, and you can use a financial adviser or wealth manager to help you build up and manage your investments.
Asset allocation is the division of your money amongst different asset classes (shares, cash, property, and bonds) to build an investment portfolio.
As you start to manage your wealth, you want to make sure that your spread of investments is suitable for you and your goals.
There are various factors that might influence the approach you take, including:
- Your goals, short and long-term
- Your attitude to risk
- Your capacity to absorb loss
Using a financial adviser will help you take a holistic approach to building your portfolio and ensure the asset allocation is suitable for you. Part of this process will include considering the diversification of your portfolio. A diversified portfolio will include different types of investments with components that perform differently under various market conditions. The aim of this is to reduce the overall level of risk when compared to a portfolio that is invested entirely in one asset class.
For example, if all your savings are in cash, it could be considered a secure strategy as it’s unlikely to lose its intrinsic value. But high inflation can erode its real-world value, and traditionally the interest earned on cash savings are relatively low.
At the other end of the spectrum, shares in a high-risk company can deliver much higher returns for your portfolio – but there’s a chance that the company fails and goes bust, leaving your investment in it worthless.
Most components in a portfolio will fall between these two extremes but getting the balance right and making sure you are invested in suitable assets is one of the skills you get from a financial adviser.
Ultimately, anything you can invest in can make up part of your portfolio, but the main components of an investment portfolio are generally made up of the following:
Cash normally sits in a standard savings account. As well as looking for the most competitive interest rate, there are a few other factors to consider, such as how quickly you can access your cash should you want to reallocate it elsewhere. It’s also important that your money doesn’t exceed any single institution’s Financial Services Compensation Scheme £85,000 limit.
The shares you include as part of your portfolio can cover various levels of risk. It all depends on the sectors you invest in, the geographic spread of the companies, and their long-term stability.
If the value of your shares remains flat or even falls, the impact of this has the potential to be cushioned by the income (dividends) you receive as a shareholder, although this is not guaranteed.
Investing in a start-up business, on the other hand, could provide a high rate of return if the business does well, but there’s a higher risk that the venture doesn’t succeed and this means your investment is at greater risk.
This is an example of why building a diversified portfolio is so important.
Investing in property does come with some risk attached – if the value of the property falls, for example – but over the years the value of property has the potential to increase.
Additionally, the property you invest in can produce income if you choose to become a landlord and let it out – it can be an asset that provides returns on a regular basis while also having the opportunity to grow in value over the medium to long term.
When you invest in bonds, you are effectively lending money in return for guaranteed interest payments over the lifetime of the bond. Bonds are issued for a fixed time period, such as ten years, and at the end of the term the initial investment is returned to you.
The annual return on a bond is called a “coupon”, which is a form of fixed-rate interest. But as with shares, the returns you get will depend on the particular bonds you invest in.
Government-issued bonds (called “gilts”) are considered lower risk as it’s unlikely the government will go bust, so the interest on these investments can be quite low.
Investing in commercial bonds – in other words, lending money to private businesses – can generate higher annual returns, but as a general rule the higher the return, the riskier the investment.
Bonds and gilts can be bought and sold during their term and the prices will differ depending on supply and demand. Therefore, investment funds that invest in bonds and gilts can also rise and fall in value.
The two main approaches of investment portfolios are geared towards income and growth.
The aim of building an income portfolio is to provide you with regular returns – money that you use to find your lifestyle, for example. In this sort of portfolio, investments that generate ongoing income such as property or bonds can play a key role.
A growth portfolio is designed to maximise your wealth in the long term. For example, your aim might be to build up your investments over a period of several decades before enjoying a pot of money in later life. The income generated by your investments in the meantime is reinvested as part of your portfolio, boosting your assets further.
But within these broad categories of portfolio are some different approaches.
Environmental, social and governance (ESG) investing is an increasingly common approach for investors who want their money to make ethical investments. This can mean investing only in companies that treat their staff, supply chains, and local communities in a certain way, or making sure your money isn’t invested in certain “sin” sectors such as tobacco or the arms industry.
Risk tolerance. Risk is a crucial factor when it comes to building a portfolio.
The overall concept is straightforward – the more risk you take with your investments, the greater your potential returns will be. Low-risk investments tend to generate lower returns, but your underlying assets are more secure.
But your risk tolerance is not the same as your risk capacity, which is your ability to take risk. The key point here is how would you manage financially if you were to suffer capital loss?
It’s one thing being an investor who is happy to take a higher risk in return for the chances of higher returns, but if that means putting all your financial assets on the line and potentially ending up with nothing, it’s unlikely to be the sensible approach.
How long you invest for is also important. If you intend to invest for the long term, you can probably take more risks. But if you want to access your money in a few years’ time, your ability to absorb risk in the meantime is likely to be less.
Every investment portfolio is built around the individual investor, but as a rule your risk profile should be lower if you can’t afford to suffer a capital loss.
Using the services of a financial planner can help you identify both your risk tolerance and your risk capacity.
Our independent advisers have vast experience of helping people manage their investment portfolios. For more information on how we can help you plan for a secure financial future, contact us on 01603 967967.
Please note, the value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future.