Investment Masterclass: Essentials

Welcome to week five of our six-week Investment Masterclass. I’m Sophie Lund-Yates, Lead Equity Analyst at HL.

Last week we covered the main types of investments, what they are and how they work. This week we’ll look at how to build your own investment portfolio.

A reminder, this course is for educational purposes and none of the information shown is personal advice. If you’re not sure which investments are right for you, please ask for advice. Investments can go down as well as up in value, so you could get back less than you put in.

Your investment strategy should be one that matches your goals and risk appetite and aims to achieve the best return for your chosen level of risk.

Let’s take a closer look at asset allocation and set out the four steps to build your own personalised portfolio from scratch.

So, what is asset allocation?

It’s a term that might sound confusing, but it’s simply a strategy for investing.

It’s all about building your investment portfolio to align with your goals, risk appetite and target returns. This is achieved by investing in a mix of asset classes like shares, bonds, funds and more, which we looked at earlier in week four.

In the visual on screen, you can see some examples of how your portfolio might look depending on how you allocate your assets. from a cautious portfolio to an adventurous one. These example portfolios only contain a mix of shares and bonds to keep it easy to follow. They also do not consider cash, however it’s important to build up an emergency savings pot before you start investing.

When it comes to creating your own portfolio there are four simple guidelines you can follow.

Number one, know your objectives.

It's important to know what you want to achieve by investing. And this might seem like an obvious thing to say, but it’s something that can go under the radar.

For most of us, we invest with a common goal: to improve our financial future and give us an income in retirement. But you can also have other key milestones along your investment journey that you need to plan for. Things like building a house deposit or helping to pay a child’s university costs.

Knowing your objectives will paint a clear picture on your investing time horizons and the level of returns you're aiming for. This, as well as your risk appetite, will help shape the overall risk profile of your portfolio.

So, number two, choosing your risk.

Risk is personal. The person best placed to decide how much risk to take is you.

Choosing your level of risk can be a difficult decision though. To help, it should mostly be about your long-term financial needs and not based on your short-term views of the market. Your strategy and mindset should also be robust enough to withstand the market ups and downs. Remember a financial adviser can act as a fresh pair of eyes and help you make the right call.

As a general rule, investors who are many years away from retirement can afford to take greater risks by investing more in shares. For those approaching retirement, it's sensible to gradually lower the amount invested in shares by increasing their exposure to bonds, which typically offer less fluctuation in returns.

It’s important to remember though, on average, we live for over two decades after stopping work, so lots of us should continue to hold some shares well into our retirement.

Number three, selecting your assets and investments.

Picking the right mix of shares and bonds is arguably the most pivotal part of the process.

Shares are riskier investments than bonds. But if you’re looking to grow your money or haven’t yet saved enough to meet your financial needs, you should consider taking more risks to try and achieve the higher returns which will help you reach your goals.

Greater risk means greater volatility though, so you’ll need to be comfortable with the market ups and downs you could experience along the way.

On the other hand, high quality bonds tend to give a relatively predictable and secure source of income. Of course, past performance isn’t a guide to the future. This can make them a sensible option for a larger part of an investment portfolio if you’ve already built a sizeable retirement pot, for example.

The second most important is to diversify.

The benefits of diversification exist because your portfolio is exposed to different types of risks. For example, investing in shares in developed markets comes with different risks to investing in shares in emerging markets.

A diverse portfolio is made up of different asset types and/or sectors in an attempt to manage risk by reducing exposure to any single asset class.

Once you have decided how much of each asset you want, you’ll need to select investments within each asset class. For any one investment, risk and return are two sides of the same coin. But when we combine investments, it’s possible to lower expected risk without sacrificing expected returns. Before you invest, make sure you understand the specific risks of the investment.

By investing in a mix of asset classes – and various equities and bonds - across different countries, industries and companies, you’ll be best placed to reap the rewards of diversification.

Number four, maintaining your asset allocation.

To help keep your portfolio on track to meet its objectives, you’ll need to make sure it’s rebalanced regularly.

Rebalancing involves selling a little of what’s done well and reinvesting elsewhere – assuming your risk level and objectives haven’t changed. That way, you will stick to your strategy, keeping the ratio of different asset classes in your portfolio steadier over time. If your circumstances change, it’s important to review your investment strategy and objectives.

We’ll go into more detail on how to maintain and review your portfolio next week.

Now we’ve completed this fifth lesson, take a few moments to complete the quiz at the bottom of this page and check your understanding of what we’ve covered.