Striking a balance in investment …

There is a commonly held belief that choosing the right balance of investments is more important than picking the right individual equities or other assets.

You wouldn’t pick all the same fruit and vegetables …

There is considerable truth in this, although what the researchers actually wrote was: “Data from 91 large US pension plans indicate that investment policy dominates investment strategy, explaining on average 93.6% of the variation in total plan return” *.

It is important to note the distinction that these were pension schemes, where the need for income is fairly predictable, but the principles can broadly be applied to individual investment strategies. Actually, it is rather like saying that you should not put all your eggs in one basket.

The benefits of asset diversity
There are indications that investors are returning rapidly to the market, particularly with the end of the Individual Savings Account (ISA) investment year looming in early April, so such issues are worth considering. Those over 50 can already put in as much as £10,200 a year each and the under 50s will enjoy the same limit from 6th April (it is currently £7,200, for them).

Quite simply, different assets – equities, property, bonds, cash and so on – have not only different costs and accessibility issues, but can also move counter-cyclically to each other. For example, when equities fall, bond values can rise; but not always. What this means is that if you spread your investments over several different asset classes, you will not do as well as if you had selected only the one that eventually turns out to have performed best, but you will not do as badly as if you had selected only the one that has performed worst.

What will happen is that you will get some of the performance of each class and this generally leads to better overall results. A more detailed analysis is contained in Money Management Magazine for November 2009 (pages 89-90).

What do we mean by balance?
Balance should not, however, simply be seen as the difference between, say, equities and property. Even within what may look like a single asset class, there are wide variations. Take, for example, equities. There are those within the FTSE100, which includes the largest companies in the UK (by market value), the FTSE250 (also called the mid-cap market because the capital value of the companies is smaller than the FTSE100), as well as smaller companies, such as those on the Alternative Investment Market (Aim).

Then again, there are different business sectors such as banks, technology, energy or manufacturing; each has the propensity to move in different directions from the other. Similarly, there are different geographical regions. Many people like to invest mainly in UK markets because there is no direct currency risk involved. However, there are times when investing in different parts of the world can offer potential benefits that outweigh variation in currency values.

... so why not consider diversity for your investments

How things can get out of balance
While it is, therefore, important to consider a realistically diverse investment strategy that is consistent with the level and type of risk that you are prepared to accept, you must also recognise that the very fact that assets will perform differently from each other means that, through time, the initial asset distribution is likely to become out of kilter. Those assets that have performed well will come to represent a higher proportion of your overall investments than was originally planned. But you may, by then, wish to reduce your risk – and the best performing assets could also be higher-risk ones.

It is, therefore, essential to review your asset allocation strategy regularly with your independent financial planner, so that you know where you stand and whether any changes need to be made.

It is important to take professional advice before making any decision relating to your personal finances. As ever the value of investments is not guaranteed and will fluctuate; you may get back less than you put in.

* (source: Gary P Brinson, Randolph Hood and Gilbert P Beebower, published in Financial Analysts Journal, July/August 1986)

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND. 

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