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One of the cardinal sins of financial planning is to put all of your investment eggs into one basket. No matter how compelling the asset or how high the potential returns, investing always carries a degree of risk. If your investment were to fail, therefore, then you risk losing everything. This is why financial planners, by and large, recommend “spreading your risk” (i.e. diversifying) across a range of investment opportunities.
However, building a diverse portfolio isn’t straightforward. There are many potential places where you could commit your capital, for instance. So which ones are best? Moreover, how do you properly manage the risks of each asset class so that they are appropriately weighted? Finally, how do you stomach the risk of investing, even with a diversified portfolio?
These are some of the questions we will be tackling in this short guide. We hope you benefit from this content and invite you to get in touch if you would like to discuss your own portfolio or investment strategy with us. Book a free consultation today on 01869 331469.
#1 Determine your goals
When you start investing for the long term, you are beginning a journey which is likely to span many years. As with any journey, it is important to determine your end-goal. Think of it as a long-haul flight; most people wouldn’t board unless they knew where they were going!
With investing, it’s crucial to think about where you want your investments to ultimately take you, and to set up important milestones along the way (to track progress). For instance, perhaps you want your investments to accumulate an £800,000 pension pot by the time you are 65. If this is your primary goal, then having shorter-term investment goals for 10, 20 or 25 years from now will help determine whether you are on course.
#2 Establish your risk tolerance
At WMM; our clients have different personalities, varying circumstances, objectives and priorities. They also have varying risk tolerances when it comes to investment risk. Some people are very risk-averse, shirking market volatility and wanting to protect the value of their assets as much as possible. Others are willing to take bold risks and almost throw caution to the wind from time to time! Most people will sit somewhere between the two.
Since investing is for the long-term, you need to feel comfortable with the level of risk you are taking with your portfolio. After all, discomfort and agitation over your investments is likely to lead to impulsive investment decisions such as selling during a temporary market fall. Many people come to regret these decisions later.
This is where working with a financial planner can add real value. They can ask you the focused, necessary questions to establish your risk tolerance and build an appropriate portfolio from there. Remember, there is no “correct” level of risk appetite. What matters is yours.
#3 Learn the different asset types
When many people think about investing they picture investors in a Dragon’s Den-style format, stroking a large pile of cash as desperate startup business owners pitch their ideas. However, this is not the type of investing most British people will engage in.
You certainly can invest in companies. However, rather than investing in each one directly (as in Dragon’s Den), financial planners will often recommend that you consider committing some of your capital towards equity funds. Essentially, these funds contain “collections” of companies, where you pool your money with other investors to invest in them.
This already starts to diversify your portfolio, as you are putting your capital to work with lots of different companies, rather than just one or two. However, there are other asset types on offer as well.
Bonds, for instance, are “IOUs” written by governments and companies, asking to borrow money from investors with the promise of eventually paying it back with interest. There are also property investments, such as Real Estate Investment Trusts (REITs), where you can pool your money with other investors to generate an income.
It’s important to try and learn about these different asset types, and to discuss with your financial planner which ones or blend of these various options might be best suited to your goals, interests and risk appetite. Each type comes with its own advantages and disadvantages too, which you need to be aware of.
#4 Look beyond asset types
You can invest in different types of assets to begin diversifying your portfolio. However, you can take things a step further by also considering different regions and sectors to invest in.
For instance, if you invest solely in banks then you potentially leave your investment vulnerable to a downturn in that sector (e.g. think of the 2008 Financial Crisis). However, if you spread your capital across a range of sectors such as energy, consumer staples and healthcare, then if one sector underperforms your portfolio will be shielded (to a degree) by your investments in other sectors which are performing more strongly.
You should also consider investing in different regions and economies with your financial planner. Different countries, for instance, might be stronger than others in particular sectors (e.g. Japan with robotics and electronics). Moreover, by investing in multiple countries you can potentially mitigate the damage that might be caused to your portfolio if you invested solely in one country, which when experienced an economic downturn. We strongly favour this Global approach to diversification.
However, it’s important to note that diversifying across lots of asset types, sectors and countries does not make you immune to investment risk. The value of your investments might go up or down, and you may ultimately get back less than you originally put in. Working with an experienced financial planner can help you minimise those risks and construct a strong, appropriately-diversified Global portfolio which stands a good chance of success over the long term.
If you are interested in starting a conversation about your portfolio, then we’d love to hear from you. Get in touch today to arrange a free, no-commitment consultation with a member of our friendly team here at WMM.
Reach us via: 01869 331469
