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Have you got the right mix for your future?
If you are a diligent
investor, you may well know off the top of your head which of your investments
performed well in 2004 and which were duds.
However, experts say
fewer savers will know how the weighting of their portfolio towards different
asset classes has changed during the year – and such knowledge is vital to good
portfolio management.
Advisers recommend
reviewing an investment portfolio at least annually from an asset allocation
point of view, but say this is often overlooked. Many expats, for example, lose
contact with their financial adviser on moving abroad, and fail to appreciate
either the change in their investment weightings or the impact of their changed
circumstances.
"Often people start
with a good spread of assets but then just don't review it, and it's very
important that they do," said Vivienne Starkey, of independent financial
adviser (IFA) Equal Partners. "What happens is that some bits do well and
some do badly, and the asset balance of the portfolio goes off."
Some investors are not
aware of the principles of asset allocation at all, and by focusing only on the
performance of individual investments they end up with a riskier portfolio than
suits their circumstances. Others are simply too passive.
Asset allocation is all
about the percentage of a portfolio invested into stocks, bonds, and other
asset classes. By spreading investments overall risk is reduced.
The most appropriate
distribution will depend on whether you are a conservative or aggressive
investor, as well as circumstances.
"The basic building
blocks for any investment portfolio are the assets of cash, fixed interest,
property and equities," explains Philip Pearson of Southampton-based
P&P Invest. "The mixture of these different assets determines the
level of risk associated with the portfolio as a whole, together with the
investment returns that could be expected over time. Asset allocation is
therefore vital, and is the first stage in building a well-balanced
portfolio."
Investors with a spread
over different asset classes will see a lower portfolio risk because of
diversification, he adds.
"So if the UK stock
markets suddenly falls in value, but you still have investments in fixed
interest and property, your portfolio will be cushioned from the short-term
fall."
While it is important not
to overreact to brief swings in asset performance, personal finance advisers
say investors should make regular checks on the asset weightings.
Mr Pearson, who
recommends annual reviews, says the beginning of a calendar or financial year
is a convenient time to assess a portfolio.
"Sometimes, however,
circumstances dictate that a more pro-active approach would be appropriate, as
with a sudden change within your life or career," he adds. "This is
particularly relevant to expats who can find themselves relocating on a regular
basis as their career develops, or who are planning to come back to the UK in
retirement."
But how should you
determine the proportion of your wealth in each asset class?
"Consider carefully
your needs for the future, whether capital growth, income, or a balance between
the two, your timescale for investment and the level of risk you are prepared
to accept in achieving your financial objectives," Mr Pearson said.
"If your
circumstances remain broadly the same in the years ahead, then the portfolio
should be rebalanced each year to take account of the change in value of each
of the individual components," he added. "This will ensure the risk
does not increase over time."
Each asset class has
distinctive features. Cash gives security, but offers lower returns. Fixed
interest offers a steady income, while commercial property brings rental income
and the prospect of capital growth. Equities offer potentially the greatest
returns but are high-risk, which is why it's wise to diversify.
"If I'm talking to a
person for the first time, I tend to start by allocating a quarter of
investments to each of the four main `pots'," said Mark Dampier, of IFA
Hargreaves Lansdown. "It's then a matter of talking to the individual
about their particular circumstances to determine the final mix."
Mr Dampier said many
investors were becoming overweight in property because of recent strong
performance, and, while cautioning that each investor had different needs,
suggested scaling back this weighting to "no more than 10pc".
"When you get a boom
in one asset, like property right now, you get people diverting their money and
suddenly you find they've got 95pc in property and about 2pc in cash, or, in
the 1987 crash, they had 99pc in equities and 1pc in cash. Then when it goes
wrong you have a real problem."
"Property is highly
illiquid, but people have forgotten that. They forget that even commercial
property funds can delay giving you your money by six months if they run into
difficulty."
Fixed interest was
another class where he recommended reducing exposure, particularly for younger
investors.
"In my view, too few
people put enough in cash," Mr Dampier added. "With interest rates
relatively low, people think they're not earning much, but they forget the
wider reason for cash, which is immediate access."
Ready access not only
offered security, it enabled investors to take advantage of attractive
opportunities in the future, he said. "People think the only opportunity
they have is when they invest today, but it's never a bad idea to have some
cash in case there's a new prospect around the corner."
Experienced aggresive
investors might choose to invest directly in equities and the other asset
classes. However, Mr Pearson said collective investment funds provided an
alternative for the risk averse and less experienced. These offer good
diversification and are easily bought and sold.
Based on an adapted article by
Carolyn Batt for the Expat Telegraph
(Filed: 23/02/2005)
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