Asset Allocation and diversification in your investments
If you’re looking to invest money for the first time, or you want to rebalance an existing portfolio, you’ll need to think about asset allocation.
Asset allocation means splitting your investment between different assets, such as cash, bonds, shares, and property. Different asset classes carry different levels of risk. The greater the risk, the more potential there is for reward, and the higher the risk of your investment falling in value.
Spreading your investment between asset classes spreads your risk. This is known as diversification and simply put, means not putting all your eggs in one basket.
Choosing the right asset allocation can be tricky, so we will always take the time to explain in plain English how this applies to your investments.
There are four main asset classes
- Stocks and shares
You invest in the shares of a company. You have a stake in the ownership of that company and benefit from any profit the company makes, through dividends.
Shares historically deliver good returns over the long term, but prices can drop too, leaving your shares worth less than when you bought them. For this reason, they are high-risk.
Government-issued bonds (or ‘gilts’) are loans to the government. You’ll be sure of getting your money back, but because they are low-risk, you might not make much return on your investment either.
Cash investments are relatively safe. Any interest you make on investments in an ISA or a pension is tax-free. But with interest rates low, you’re unlikely to see much return on your investment. You’ll also need to consider the rate of inflation.
When inflation is higher than the returns on your investment, your funds are effectively losing value in real terms.
Investing in property can be risky. Not only can property prices rise and fall, but you can also find your money gets tied up when you come to leave. This is because you’ll need to wait for the sale of the property to free up cash.
A recent example of this issue occurred in March. Stock market volatility caused by the coronavirus pandemic made it difficult for valuers to accurately value their fund’s underlying assets. As a result, UK commercial property funds were suspended, ‘trapping’ almost £22 billion of investor’s money.
Your optimal asset allocation depends on many factors
The right asset allocation for you will depend on your circumstances. You might have a new family and want to invest for your child’s education. Or maybe you’re investing for your own retirement, still decades away.
By speaking to you, getting to know your circumstances and aspirations, we can allocate your assets in a way that works for you. We’ll take several factors into account, all of which are closely linked:
- Your goals
Your overall investment goals will have a massive bearing on the best asset allocation for you. If you’re saving for your own retirement, the length of investment might be decades away, and that means that you might be willing to take more risk.
- Your attitude to risk
Your attitude to risk will be linked to your investment goals and the length of your investment but will also take into account your capacity for loss. How much can you afford to lose?
If you can only afford modest losses, you’ll need to opt for a lower risk approach. If you can afford to lose a larger portion of your initial investment, you can afford to run a higher risk, giving yourself the chance of making higher returns.
- The length of your investment
Investing should always be for the long term – five years as a minimum, but ideally for much longer.
The general trend of the market is an upward one. A lengthy investment gives you the best chance to see good returns, while also protecting you against the kind of short-term volatility we saw at the start of the year as the markets reacted to the coronavirus crisis.
When you’re young, or in the so-called ‘accumulation phase’, the higher risk might enable you to see greater returns while you still have plenty of time to recover if the markets drop.
As you get closer to retirement, you will enter the ‘consolidation phase’. You’ll soon need access to your investment, and you won’t want to risk it dropping at the worst possible moment. You’ll want to consolidate the gains you’ve made by lessening your risk.
Your asset allocation – like your attitude to risk and your capacity for loss – is not a static thing. This is why we will review it with you each year and make sure it changes as your circumstances change.
Diversifying your portfolio spreads risk
Diversification is a way of spreading your investment risk. As well as investing in a range of asset classes that match your risk profile and align with your goals, you’ll also want to think about other factors too.
Investing in different sectors or industries, and in different parts of the world, further diversifies your portfolio.
A diversified portfolio means that if share prices drop in one part of the world, or one sector suffers losses, your loss might well be counteracted by a rise in investments you hold elsewhere.
Get in touch
Understanding the importance of asset allocation and diversification is key to successful investing.
Contact us at firstname.lastname@example.org if you have any questions on asset allocation. Our fully regulated and qualified team of professional financial planners would be happy to explain things to you in more detail.