Much is written about asset allocation, but many investors refuse to acknowledge its benefits, or feel their investment portfolio is too small to warrant applying what sounds like a lot of complicated mumbo jumbo.
However, the principle is quite straightforward. By and large, your assets will fall into one of four self-explanatory categories: equities/shares, fixed interest (i.e. bonds), property and cash. Depending on the point of the economic cycle, certain assets perform better than others.
Most research into investment performance shows that the best returns are not generated by the ability to pick the right shares, but the ability to allocate your capital to the right assets at the right time.
Equities still dominate
Over the past 100 years, equities have consistently outperformed all other asset classes, such as property or cash. According to The Global Investment Returns Yearbook (produced for ABN AMRO by the London Business School), an investment in UK equities of £100 at the start of 1900 would, with dividends reinvested, have grown to more than £2.1 million by the end of 2006, a return of 9.8 per cent per annum. Long bonds and treasury bills gave lower returns of 5.4 and five per cent per annum respectively, although they did beat inflation. However, £1 invested in a savings account over the same period would be worth just £184 if all the interest had been reinvested.
But perhaps the first question investors have to ask themselves relates not to which assets will perform well in the future, but to their attitude to risk. ‘We always ask a client what their primary objective for investing the capital is – capital growth or income?’ says Sheridan Admans, an investment adviser at The Share Centre. ‘Both objectives need very different asset allocation strategies. The other questions I’d ask are how long the investor’s investment time horizon is, their current age, when they intend to retire and whether they have any outstanding loans and liabilities. You should consider all your current liabilities ahead of any investment, so if you have debts, paying them off is a far better allocation of your capital than investing.’
Safety first
Admans adds, ‘We always recommend that a customer has access to a fund of money for financial emergencies and short-term planned expenses. This should be at least three times the customer’s monthly income. If this amount is not available, they should initially save it in cash deposits for easy access and security.’
Admans says there are no hard and fast rules to asset allocation models and that, when building a portfolio for customers, there is a balance to be struck between investors’ objectives and their attitude to risk. He says that the five example portfolios would be a starting point, but would change when an investor’s objectives and risk attitudes are factored in.
How great is your appetite for risk? Only you know. *p>Copyright Vitesse Media
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