By: BILL BLEVINS
Financial Correspondent, Blevins Franks
A proven method of successful investing is through asset allocation, the selection of which investment assets to include in your portfolio, and how much of each. The right portfolio, skilfully collated to cater for your personal needs, can provide you with income as well as allowing your capital to grow.
The investment industry acknowledges that over 80 per cent of value is added to a portfolio through asset allocation.
Your investment portfolio should be put together to suit your personal circumstances, aims and objectives. If you require regular income to supplement a pension, for instance, your portfolio can be designed to focus on this. For people who want to create more wealth to leave to their heirs, a portfolio can be compiled with this objective in mind.
One of asset allocation’s prime objectives is to lower risk, and your financial adviser will establish the risk level that you are happy to accept and then determine which allocation of assets will achieve this.
Usually, the higher level of risk you accept, the more likely the returns will be higher. The majority of retirees, however, feel more comfortable with a lower level of risk that produces consistent returns and steady capital growth. Lowering the risk level of a portfolio does not necessarily mean returns will be very restricted; with strategic asset allocation you can still aim for steady returns at the same time as keeping risk under control.
It is recommended that you seek expert advice to establish the asset allocation that will work for you.
The four major categories that usually make up a well constructed investment portfolio are equities, bonds, property and cash. These can then be individually diversified across different management styles, sectors, geographical zones and currencies.
The key role equities play in an investment portfolio is capital growth – they provide the best opportunities for good returns. Capital growth is a major defence against inflation, which is a constant threat to wealth preservation.
When you invest in equities you are buying a share of a listed company. You should have a well-balanced spread in your portfolio and this is usually best achieved through buying equity funds. Your adviser would normally recommend you buy a few funds, which together will cover established and new companies; large and small corporations; different industries and countries.
Higher returns offered by equities are accompanied by higher risk, but since this is only one section of your portfolio, the risk level will be balanced out by the other assets. Buying well diversified equity funds also helps lower risk and the equity portion of your portfolio should be held over the longer term.
Bonds can play many roles in a portfolio – they provide income, they balance out equities (thus lowering overall portfolio risk) and also provide gradual capital growth over the longer term.
When you buy a bond you are lending money to a government or corporation in return for regular interest payments and a return of your capital outlay after a set period of time.
Government bonds are generally the safest form of bond investment and consequently offer the lowest yields. Corporate bonds are categorised accordingly to their credit worthiness. High yield bonds give the highest return and are usually from young corporations or emerging markets.
Like the equity allocation, bonds should be well diversified and best bought as a bond fund. Usually, it is enough to buy one well diversified bond fund, but you may wish to include more than one fund to include specific sectors, for example, high yield bonds and bonds from emerging market economies.
Property is generally considered to be a secure and rewarding investment. Owning direct property, however, is rarely an option because of the initial capital outlay and the lack of diversification possible.
Then there are maintenance costs to consider and taxes like purchase tax, tax on rental income, council tax and capital gains tax. When you want to sell it is not all that simple either, depending on market conditions. Ease of liquidity can be a problem and you cannot depend on realising this asset quickly if the need arises.
One way to overcome these potential drawbacks is to buy a property fund. This can consist of industrial, commercial and residential property from all over the world, usually a collection of prestige property with secure rental agreements.
One such fund is called a Real Estate Investment Trust (REIT) that provides a regular income in the form of dividends and good potential for capital growth. A REIT is structured so that there are no capital gains or other taxes to pay except for the personal tax on the dividend income.
Two other advantages of a REIT are that they offer protection from inflation in the form of capital growth and they have a low correlation with equities and bonds.
Your investment portfolio should also have a certain proportion allocated to cash. In deciding on how much you can afford to invest it is wise to keep some cash readily available for unexpected expenses without having to draw from the other allocation of assets.
Once you and your investment adviser have decided on how to allocate your assets your portfolio could be wrapped up in a life assurance bond for improved tax efficiency, and reviewed annually to keep up with any changes in the investment world and your personal circumstances.
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