Perhaps the single most important factor that determines the success of a chosen investment strategy is how risk and reward are balanced. Investors are always keen to maximise returns where possible, but it is important to bear in mind the level of risk that is being taken in trying to achieve an investment goal.
One of the key building blocks of any successful portfolio strategy, and an effective way of reducing portfolio risk, is to add different types of investments and blend them together, so that a diversified portfolio is created. Holding a diversified portfolio can help reduce risk, as different asset types tend to behave differently. This can help smooth returns in periods when markets are volatile and avoid being over-exposed to one particular investment.
Diversification can be achieved in a number of ways, and a good starting point is to consider the allocation given to each different type of asset in the portfolio. Whilst many people will hold shares in their portfolio, adding government bonds, property, alternative investments and cash to the mix will help diversify returns, as each of these asset classes usually behaves differently.
Further diversification can be achieved by broadening your horizons. We see far too many portfolios that are heavily weighted towards UK shares, and investing in other areas of the World, such as the US, Europe, Far East and Emerging Markets can seek out investment opportunities in different geographic regions. This can reduce risk, as it is often the case that the economic prospects of developed and emerging nations can look very different at a particular point in time.
Holding individual shares also introduces risk, which can be reduced by investing in a collective investment fund, such as a Unit Trust. These investments hold a range of positions, so instead of investing in one, or a handful of companies, you gain exposure to a much wider range of companies across different sectors of the economy. This won’t prevent the portfolio rising and falling in value but does limit the potential negative impact of poor performance of an individual stock on the overall performance of the portfolio.
Concentrating investments in one sector of the economy can also introduce risk, as difficulties faced by one company can often spread across similar companies. Take general retailers for example. If high street spending falls, due to economic contraction, then this is likely to affect most major retail stocks. In this scenario, holding a portfolio of retail shares is not going to provide adequate diversification, as the price of all shares in the sector may be adversely affected.
Whilst portfolio diversification is a proven investment theory, it does not remove the need to consider the investment strategy adopted regularly, to ensure that the investments held continue to meet your needs and objectives and remain appropriate given the prevailing economic and market conditions. This was more true than ever last year when the mix of high inflation and rapid interest rate hikes caused risk assets to move in a similar direction at the same time. This underlines the importance of tailoring the portfolio approach to fit the prevailing and expected conditions.
Keeping a portfolio under regular review is just as crucial as the initial construction phase and this is where an ongoing review service offered by an independent financial planner can add value, by making changes where appropriate to position the portfolio for the expected conditions. Our experienced Investment Committee undertake a comprehensive review of investment markets regularly, and the CDI portfolios undergo a rebalance at least four times a year. Indeed, two further rebalances were undertaken in 2022, one immediately after the Russian invasion of Ukraine, and the second in October following the ill-fated mini-Budget and stress seen in Bond markets at the time. These are both good examples of the need to adjust a portfolio strategy in response to global events and changes in underlying investment conditions.
If you hold an investment portfolio that has not been regularly reviewed or wish to invest capital in an actively managed and conviction-based investment approach, then speak to a financial planner on 01303 273273 about CDI portfolios.