A Simple Guide to Asset Allocation

A Simple Guide to Asset Allocation

Investing presents great potential rewards in the form of monetary return, but it also involves risk. The amount you get back from your investment – and the degree of risk involved – depends heavily on the type of asset you invest in.

UK government bonds, for instance, are generally seen as “lower risk” and “lower return”. Investing in startups via the Enterprise Investment Scheme (EIS), on the other hand, is broadly seen as “higher risk” and “higher return”.

Knowing about the different types of investment assets, as well as the returns and risks involved, is crucial for any investor. Not only will you minimise your risk of loss, but you will also maximise your opportunities to get more money back than you originally put in.


Know Thyself

Before we broach the subject of different types of assets and how to allocate them, it’s important to take a look at yourself. In particular, what are your investment goals, and how much risk are you prepared to take in order to achieve them?

It might be that you are a young Sophisticated Investor, for instance, who has significant sums to invest as well as an appetite for investment risk and rapid wealth growth. This sort of person will likely have a very different risk profile and investment goals from a wealthy retired person, who perhaps simply wants to preserve their wealth in order to maintain their lifestyle.

It’s always a good idea to seek out the counsel of a qualified, experienced independent financial adviser prior to making any big investment decisions. With that in mind, let’s now look at some of the different investment types available to you when putting together an investment portfolio:


#1 Cash

Probably the most widely known asset, the most common types of cash investment include bank and building society accounts, as well as money market funds.

Your money is arguably quite safe in the bank, especially in light of the Financial Services Compensation Scheme guaranteeing up to £85,000 if your bank fails. However, cash is also widely seen as a poor investment choice when it comes to getting a return on your money.

Inflation is currently beating interest rates at the moment and is likely to continue to do so for the foreseeable future. In effect, therefore, you are often actually losing money by holding large sums of tax in a bank account! Factor in that the interest you earn can also be taxed, then that’s even more erosion going on (although you do need a quite a large amount saved before you start getting taxed on the interest).

All of that said, cash does have its uses – especially as a buffer in the event you fall on hard times. Digging into savings to keep you afloat is certainly better than falling into debt.


#2 Bonds

You can borrow money through your bank or credit card. Governments and companies can borrow money too, although they tend to do this by issuing “bonds”. These are a bit like “IOUs”. You can accept a bond by agreeing to lend the issuer money on the premise that they pay you back in the future – with interest.

Bonds tend to be a fairly low-risk investment, depending on who the issuer is. UK government bonds, for instance, are generally seen as quite safe because the government is seen as unlikely to go insolvent. On the negative side, however, lower risk bonds tend to present a lower return on your investment.


#3 Equities

The word “equities” is generally used as a name for shares in companies. These are generally seen as higher risk investments than bonds, for instance. This is because if the company you invest in fails or hits financial hardship, bondholders will be prioritised before shareholders when it comes to distributing the company cash.

However, equities also tend to carry the potential for higher financial return. Whilst a bond matures at the same price it was initially issued, share prices can dramatically increase in value if the company is highly successful. This can give you more income through dividends, or you can choose to sell the shares at a higher price compared to when you initially bought them – bringing in a profit.


#4 Property

Investing in property usually means investing in real-estate such as office buildings, retail units, warehouses and residential property. Whilst buying bonds and equities is a relatively quick process, investing in property is usually a lengthy process involving valuations and legal work.

Whilst property investments are relatively illiquid (i.e. it isn’t as easy to get your money out if you want to), they do tend to experience significant shifts in capital value. This usually puts it in the category of “higher risk” and “higher return”, since that value could go either up or down.


Allocating Your Assets

If we had a crystal ball showing us everything that will ever happen, then asset allocation would simply not be necessary. Financial advisers guide their clients towards diversifying their assets precisely because the future is uncertain.

Particular assets and asset classes might do very well, as hoped for. Or they might fail miserably. If the latter transpires, you can shield yourself from significant financial pain down the line by not putting all of your eggs in one basket. If your property investments fall, for instance, but your equities do well, then you might still make an overall return on your investment portfolio.

Your own precise combination and mixture of cash investments, bonds, equities, property and other assets will depend on a range of factors. For instance, your attitude to risk will be an enormously important factor. As will your investment goals, as well as the prevailing market environment.

The crucial thing to remember is that investing is for the long term, and that it involves risk. You should, therefore, make sure you are fully informed about your options, prior to making any big investment decisions. By speaking with an experienced financial adviser, you can safeguard your portfolio against blind spots and ensure you make smarter decisions with your money.


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