Frequently Asked Questions
How can I build the right sort of investment portfolio?
The building of an investment portfolio is a complex task and is the part of financial planning where virtually all private clients should and do seek professional advice. There are many contributing factors which will affect the eventual composition of the portfolio.
Each investor is different. For example, an investor may be working, independently wealthy, approaching retirement or retired. They may have saved the capital for investment, inherited it, sold an asset or have received a pension tax-free sum.
Age and investment timescales are very important factors and these obviously vary enormously. For example, younger investors are able to absorb higher risk over much longer terms than those investors already in retirement as they will have much more time to recoup short term losses due to market volatility.
The objective of the portfolio is different from investor to investor. Is the purpose of the portfolio to increase in value over time, is it to finance a child’s education, purchase a second home or increase income in retirement? Is it aimed at capital growth or to provide an income? Determining the objective, in line with any existing savings and investments and outstanding financial commitments is a fundamental step in portfolio construction.
However, there is always a constant to work with — risk tolerance.
Some investors are prepared to accept a higher degree of risk with the potential for a greater level of return and others are not. It is therefore extremely important to work out the acceptable level of risk attaching to any portfolio under consideration.
This will dictate the mixture of investments which can be included — this is termed the asset allocation.
Whilst risk will mean different things to different investors, and far more than I can cover here, a broad brush outline follows:
- A low risk profile means an investor places more importance on the preservation of capital than on increasing its value. Typical investments at this level will include cash deposits, bonds and government securities.
- A medium risk profile typically means that an investor can tolerate some fluctuations and volatility but will still tend to stay away from investments and asset classes that may have dramatic or frequent changes in value. The medium risk investor will usually have a medium to long term goal for investment and will usually favour a combination of equities (stocks and shares) and bonds.
- A high risk profile investor is willing to accept a far greater possibility of short to medium term losses in the value of their portfolio in return for potentially far higher returns over the medium to long term. They typically will accept a far wider range of investments within diversified asset and sector classes (ie smaller companies, emerging markets etc). A much higher proportion of the portfolio will be invested in equities rather than bonds. These clients tend to have the longer investment durations (sometimes termed investment horizons).
Risk tolerance can change over time as can the suitability of the assets held so it is extremely important to regularly review the portfolio for appropriateness, performance and attaching charges.
Finally, the tax treatment of the portfolio should be as advantageous as possible to maximise the available returns to the investor.