Creating and maintaining the right investment strategy
The single best way to protect your portfolio is to spread your risk across several different types of investments. There are many different assets in which you can invest, each with different risk characteristics. While the risks attributable to assets cannot be avoided, when managed collectively as part of a diversified portfolio, they can be diluted.
The overall level of risk exposure
The main assets available are shares, bonds (also referred to as ‘fixed interest’), cash and property. While individual assets have a bearing on the overall level of risk you are exposed to, the correlation between the assets has an even greater bearing.
The aim is to select assets that behave in different ways, the theory being that when one is underperforming, the other is ‘outperforming’. Fixed interest investments and property, for example, behave differently to share-based investments by offering lower, more consistent returns. This provides a ‘safety net’ by diversifying away many of the risks associated with reliance upon one particular asset.
Spreading investments across different assets
Keeping track of lots of individual assets can be a daunting task. A much simpler solution is to
acquire investment funds containing those
assets and leave the diversification worries to
a professional management team. By purchasing
a fund that invests in, say, large blue chip companies, another that invests in smaller growth companies and others that invest overseas, you can spread investments across hundreds of different assets.
Reduce share-specific risk investments
You can diversify within assets. For example, you can spread your investments into different shares or bonds to ensure your portfolio is exposed to lots of different types of investments rather than, for example, having shares in just a few large companies. In that way, share-specific risk can be reduced should one of those companies experience difficulties.
Different sector and company exposure
It is just as important to spread your investments across different sectors as well as different companies. Companies are classified by the sector in which they reside, which is dependent on the goods or services they sell or provide. BT, for example, resides in the Telecommunications sector and Shell in the Oil and Gas sector.
For many reasons, companies within different sectors perform in very different ways. By diversifying across sectors you can access shares with high growth expectations, without overexposing your portfolio as a whole to undue risk.
Geographical diversification can achieve better returns
It may be natural to feel more comfortable investing a portfolio in your home market, but this is not
necessarily the most sensible option. Because investments in different geographical economies generally operate in different economic cycles, they have less than perfect correlation. That’s why greater geographical diversification can help to offset losses in a portfolio and help to achieve better returns over time.
An investment style to suit your needs
Investment style is another important aspect to consider when building an investment portfolio. Some investment funds use a ‘passive’ management approach, which aims to mirror or ‘track’ the performance of a financial index. This is normally done either by investing in the exact constituents of an index or by taking a representative ‘sample’ of that index.
This means that these funds simply track the performance of a chosen index, for example the FTSE 100. Other funds use an ‘active’ approach and aim to beat the index by using their own research and analysis to select shares they believe will achieve greater returns. There are many reasons for using both types of strategies, and obtaining professional financial advice will enable you to assess which approach is best suited to your needs.
Levels and bases of and reliefs from taxation are subject to legislative change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested.