All investments, including cash deposits, carry a degree of risk but some are more risky than others. Once you have established a solid foundation of savings for the short term, you may look to investments to provide more growth potential over a longer period, typically five years or more. There is no one investment strategy that suits everyone and your decisions on how to divide up your investment portfolio into different types of investment will change over time.
If appropriate to your particular situation, the start of the new 2011/12 tax year is a good time to reconsider your attitude towards risk for return and give some thought to whether the structure of your portfolio is still in line with your investment aims and objectives or whether your investment attitude has changed. Also, in the current economic climate, with interest rates so low and the prospects of future rising inflation, you could be losing out by keeping your money in a savings account because inflation is beating the return on interest rates and, therefore, the real spending power of your money is less.
The importance of diversification
You should consider the weighting and balance of the constituents of your portfolio. Above all, there is the importance of diversification, both geographically and between sectors, even between asset classes and the weightings you wish to keep in each part of your portfolio. Not having all your eggs in one basket means that if one part of your portfolio underperforms, this could be compensated for elsewhere.
When you choose to invest, your money can be spread across five main types of asset:
– Cash
– Gilts (Government bonds)
– Corporate bonds
– Equities (stocks and shares)
– Property
You should remember that different types of investments may receive different tax treatment, which could affect your choice. These asset classes have different risk characteristics and whilst these implicit risks cannot be avoided, they can be mitigated as part of the overall investment portfolio by diversifying.
Saving your money in a range of assets helps reduce your exposure should one of your investments suffer a downturn. For many investors the creation of a ‘balanced’ portfolio means spreading investments across a range of products to minimise risk exposure.
Given some forward planning, you could decide on the amount of risk with which you’re most comfortable. By spreading your investments over a wide range of asset classes and different sectors, it is possible to mitigate the risk that your portfolio becomes overly reliant on the performance of one particular asset. Key to diversification is selecting assets that behave in different ways.
A ‘safety net’ by diversifying
Some assets are said to be ‘negatively correlated’ – for instance, bonds and property often behave in a contrary way to equities by offering lower, but less volatile returns. This provides a ‘safety net’ by diversifying many of the risks associated with reliance upon one particular asset. It is also important to diversify across different ‘styles’ of investing, such as growth or value investing, as well as across different sizes of companies, and different sectors and geographic regions.
Growth stocks are held because investors believe their value is likely to grow significantly over the long term, whereas value shares are held because they are regarded as being cheaper than the intrinsic worth of the companies in which they represent a stake. By mixing styles that can outperform or under-perform under different economic conditions, the overall risk rating of the investment portfolio is reduced. Selecting the right combination of these depends on your risk profile, so it is essential to seek professional advice to ensure that your investment portfolio is commensurate with your attitude to investment risk.
