Who might benefit from this page?
- Individuals with existing long-term investments or deposits
- Individuals looking to make investments for the first time
- Trustees or Powers of Attorney looking after money for others
Anyone who has spent anytime watching investment markets will have noticed their capacity for volatility and unpredictable behaviour. It often seems that successful investing requires the ability to predict the future, an ability that even investment professionals lack (except in hindsight!). If the professionals cannot ‘time markets’ with any consistency, where does that leave the private investor?
What benefits can be gained?
By adopting an investment strategy based around asset allocation rather than market timing the following benefits might be gained.
- A portfolio can be constructed with assets in proportion to the level of risk you desire and doesn’t swing from low to high risk as you switch assets to ‘catch’ the market.
- By mixing assets that work best in different market conditions a more robust portfolio can be constructed - such portfolios are less susceptible to economic or financial shocks that tend to impact on a particular type of asset
- By concentrating on the underlying assets instead of the product or fund, portfolios can be made more cost-effective when your strategy changes.
Whilst none of us has a crystal ball, by following a well proven strategy of combining different types of assets it is possible to construct portfolios designed to cope with a variety of investment conditions and escape the trap of trying to time the market
What is Asset Allocation?
When conducting a Government review of the investment market in 2002 Ron Sandler commented on the importance of the technique of ‘asset allocation’ noting that “the asset allocation decision is by far the most important factor in determining returns.”
Asset allocation is the process of combining assets in a portfolio to meet the particular objectives and risk tolerance of an investor. Of greater importance than the choice of investment provider or fund manager it is the mix of assets in your portfolio that will primarily determine the results you receive and the risk you take to get them.
One of the benefits of this approach is that a number of providers, ‘wrappers’ and funds can be combined taking advantage of the benefits each might offer yet still arriving at an overall portfolio designed to meet the objective.
Examples of asset allocation
In the majority of cases a good asset allocation is one that mixes different asset classes to compile a portfolio that can meet the challenges of an unpredictable future. Here are two example portfolios that use asset allocation as the fundamental building block:
Either of these portfolios might be employed by different investors with different objectives and different approaches to risk. You might notice the following about these two charts
- The types of assets are the same but the mix is different – the cautious portfolio has more fixed interest and cash investments than the adventurous one
- They may use some of the same funds or investment products
- Neither portfolio is determined by the type of product - they could be pensions or ISAs (or both). Instead they are determined by the type of assets held.
- Both portfolios contain assets which are expected to offset the negative impact of other assets – when shares do poorly gilts and corporate bonds often do better and this reduces risk in the portfolio.
The efficient frontier
Asset allocations are not just random combinations of assets. Efficient Portfolio Theory provides a method to construct portfolios where the combination of assets is created to fall along a line which provides the most efficient trade off between risk and reward based on the assumptions made about those factors.
What actions can be taken?
Whether you are making a new investment or reviewing an existing portfolio the following points might be helpful.
- Do you have a clear idea of what you want from this investment? Is it income, growth or both?
- Is the portfolio heavily exposed to one or a few asset classes?
- Could using a mix of different assets reduce the risk in this portfolio?
- How would your portfolio match up to the Efficient Frontier?
- If you are relying on timing to get into and out of investment markets how will you make this decision?
How we can help
- We operate a formal asset allocation process which can be used for a single investment or to review all of your investments.
- We offer a range of benchmarks to suit a range of risk profiles and objectives
- As independent financial advisers we can take account of your existing plans and build them into a comprehensive asset allocation strategy
- Once your strategy is determined we can advise on appropriate products, funds and tax wrappers.
- We offer an ongoing review service to keep your portfolio on track.