We always hear the saying “don’t put all your eggs in one basket…”, but do we sit up and take enough notice?
Investors who have adopted a single strategy approach to their investments have in many cases been shocked by the uncertainty and often the volatility of the returns in their portfolios.
Performances of the various asset classes have varied over the past ten years. Equities have performed best five times, and rock bottom three. Property was tops only three times, Hedge Funds were best twice but never bottom. Bonds were never tops, but second twice. Cash was never best, but was worst four times.
It is very difficult to predict which asset class is going to perform best on a yearly basis. However, many of us try to do this, and get our fingers burnt because past performance is not an indication of future performance.
Lessons learnt
Diversification is the surest way of reducing risk and makes for a less volatile portfolio. Diversifying amongst some or even all of the above-mentioned strategies is the best strategy for the average investor.
Everyone’s circumstances differ and this also determines your investment strategy. Investing to maintain your lifestyle in retirement for example, is a very different process and requires a completely different investment strategy from those attempting to create wealth. Those already in retirement need to consider life expectancy and ensure that they will still achieve growth on their investments.
When making diversification decisions, you need to consider:
- Time horizons
- Expectation of return
- Appetite for risk
- Liquidity
- Income needs.
Making the right choices
Below are some basic guidelines in helping you to make these decisions:
- Be realistic: A conservative investment is not going to double in value every five years, an aggressive portfolio is not going to give you a smooth ride.
- Patience: If you are taking a long-term view don’t stress about short-term fluctuations in markets and currencies, they are part and parcel of investing.
- Goal setting: Understand what you are trying to achieve with each investment you make.
- Be proactive: Rebalance a portfolio if the percentages allocated to your chosen asset classes are out of kilter. This ensures you lock in profits of any asset class that has become either overweight or underweight because of market volatility.
- Time horizons: The less time you have to commit to your investment, the less risk you can afford to take. If you are investing for growth be prepared to allocate more to higher risk asset classes but be committed to a period of at least ten years.
- Security: Do your homework! It is important to know who you are investing with. If you are offered interest well above the going rate, beware. Many people have lost their life savings chasing that extra percent.
- Plan for Tax and Estate Duty: There are many legal ways to reduce tax and estate duty, and thus enhance the growth of your investments.
- Knowledge: There is no longer any excuse for investors to claim they did not understand before renewing or making a new investment. Intermediaries are obliged to provide appropriate advice on risk and costs. Understand all the implications before you sign.
- Shop around: If you don’t feel completely comfortable with any aspect of the advice you are getting, ask for a second opinion. The decisions you are taking now may be critical to your future. You need to feel totally confident that your financial planning is secure in your advisors hands.
Following some of the above guidelines will assist in properly diversifying your assets and prevent you from making investment decisions that are not suited to your portfolio.