Smart investing is all about balance. Before you hand over your hard-earned money, you need to make sure that you are aware of the inherent risk involved with any investment, as well as the potential rewards. This usually means splitting your portfolio between traditionally ‘safe’ assets such as long-term bonds and fixed income, and the more unpredictable equities market.
Even within these two asset classes, diversity is the key to balance — you would never keep all your cash underneath your mattress, or bet everything you own on a game of poker. Likewise, a good investment portfolio will be varied and thought-through. Under ‘equities’, you might include a mix of tech stocks, commodities, and healthcare shares, or you might use an exchange traded fund (ETF) to give you automated diversity by tracking the performance of an index like the FTSE 100. Within your ‘fixed income’ portfolio, you might have some treasury bonds, some corporate bonds, and some asset-backed securities, for instance.
Watch now: Investing: the power of diversification by Andrew Craig, author of ‘How to Own the World.’
The exact split of an investment portfolio is very much down to each individual. However, there are a few steps that everyone can take to ensure that they are building a balanced portfolio that fits your specific needs and expectations.
Creating a balanced portfolio
- Step one: set your goals
Before you start putting your portfolio together, you need to identify your investment goals. If you are saving for retirement, for instance, you can afford to tie your money up in 20-year bonds or other long-term investment schemes, and this can be reflected in the ‘fixed income’ side of your portfolio.
If you think you might need to access your money in the medium term (for instance, to pay school fees, or fund a wedding), you will want to consider investment options which have some degree of flexibility. ETFs are a great option for medium-term investing, as they tend to come with very low fees and excellent liquidity. Since they track stock market performance, the longer you leave your money inside an ETF, the more likely you are to get a better return, despite any short-term volatility.
For short-term investment goals, there are a lot of instant-access accounts out there which offer paltry returns (usually under 1%) for the convenience of allowing you to withdraw your money at a moment’s notice. Given that the current rate of inflation is at a four-year high of 2.7%1, these accounts will never produce a real return on your investment. Alternatively, most Stocks and Shares ISAs will allow you to cash out or make partial withdrawals at a short notice, while also delivering strong potential returns over the long term.
- Step two: find your balance
Once you have set your goals in place, it’s time to get to grips with your risk profile. Some people are averse to any kind of risk and would rather leave their money in an under-paying cash savings account, for fear of making a bigger loss on a less predictable investment. Others are comfortable chasing the double-digit returns offered by alternative asset classes such as emerging markets or private equity.
A well-balanced portfolio will find a happy medium between high-risk and high-return options, and the low-yield but steady accounts. For most people, this means a roughly 50/50 split between equities and fixed income, with perhaps 5% carved out for alternative investments.
You can work out your own risk profile by taking into consideration your age (the younger you are, the more risk you can afford to take), your financial commitments, your dependants, and your investment goals.
It is widely believed that there are five distinct risk profiles ranging from ‘cautious’ to ‘aggressive.’2 Once you have worked out where you are placed, you will have a better idea of what your balanced portfolio should look like.
- Step three: regular reviews
Your idea of a balanced portfolio is likely to change over time. Investors tend to become more conservative as they get older, and after a decade or so of investing, you will have a better idea of what works for you. For instance, if your fixed income investments have underperformed for a few years, you might want to move more money into equities. Or if one of your stock picks has been giving you anxiety over its volatility, you may decide that you’d rather avoid that sector in the future.
It’s very important to review your portfolio every few years to ensure that it is still working for you, and don’t be afraid to ask for expert advice if you need to.
This Article Was Originally From *This Site*
Powered by WPeMatico