Instead of paying a professional, like Wealthify, to build and manage their investment portfolio, some people prefer to do it themselves and select their own funds or individual stocks and bonds, using an online trading platform.
If you’re that person, or simply curious about how to approach it, here’s how to build a diversified portfolio without an investment manager.
Consider your asset allocation
Asset allocation is the investment recipe to build your portfolio. It determines where you invest, what type of investments you select, and how you build your investment portfolio.
There are four key areas to focus on that will help guide your asset allocation choices.
How long are you investing for?
The length of time you’re investing for will have a huge impact on what you invest in and where. Typically, the longer you’re invested for, the more high-risk investments, like shares and property, should be included. As your time frame becomes shorter, a greater allocation of bonds and cash equivalents should be considered.
How much experience do you have?
When building a portfolio for yourself, make sure you consider your level of experience. Like anything that you do for the first time, it’s probably wise to start off small, learn from your mistakes, and work your way up.
If you’re just getting started with investing, it could be a good idea to consider investments that historically offered lower returns to reap the comfort of lower risk. The most important step is to build up your experience managing a portfolio, then when you’re more comfortable, take some time to reassess your risk level. Investing all your savings in small lithium mining companies because a friend of yours recommended it could be ill-advised, even more so if it’s your first time. So, play it safe.
What’s your attitude to risk?
Irrespective of time frame and experience, if you’re naturally a cautious person you may want to build an investment portfolio with investments that don’t usually experience big price fluctuations. Vice versa, if you’re comfortable seeing fluctuation in the returns of your portfolio, you may lean towards a more adventurous style of investing.
How much spare time do you have to manage your investment portfolio?
The amount of spare time you have will impact your asset allocation when opting for a DIY approach.
Different types of investments you select will require differing degrees of time and input. It‘s important to gauge how much time you have to do your research and manage your investments.
If reading through quarterly reports and other company announcements sounds like a responsibility you don’t have time for, perhaps, instead of picking your own stocks and shares, you should look to funds that will pick the companies on your behalf (active) or replicate the returns of global stock markets (passive).
OK, now that you’ve successfully selected what to invest in and where, it’s time to choose those investments! You have a choice of individual stocks and bonds, active funds, and passive funds.
Stocks and bonds
With this approach, you look for companies to invest in and typically select a number of shares or bonds in the hope of seeing your investment plan increase in value over the long-term.
By adopting such a strategy, you have complete control over the companies you invest in. You can follow them on the news and act rapidly if anything was to happen. But, more importantly you have a chance of much higher returns than the other options, especially with shares.
However, picking individual investments means you need to do a lot more homework, researching countries, sectors, and companies. You will need at least a basic knowledge of economics and accounting, and you should be able to read through a set of company results as well as know your way around a company balance sheet. And all of this takes time!
Your portfolio will also carry a greater amount of concentration risk compared to other options. In other words, you’ll be filling a small basket with too many eggs, the opposite of diversification, where you’re spreading your money across investment types and regions.
Active funds are another option to get your desired asset allocation for your investment plan. They are managed by a fund manager whose job is to pick a collection of shares, bonds, and other investment types to perform better than a predetermined benchmark.
A UK equity manager may have the FTSE 100 as their benchmark and are paid to perform better than the average return of that stock market.
The good news with active funds is that you can buy 10 of them and get much greater diversification than buying 10 individual investments. It would be uncommon for an active fund to hold less than 50 underlying investments, so, through using active funds, you’re looking at holding at least 500 underlying investments compared to a hypothetical 10 stocks or bonds.
In addition to diversification, you’ll get an army of trained analysts doing the hard work for you. All you need to do is research the fund managers and compare their performance.
One thing to keep in mind though is that active fund managers have a difficult job to do. They’re charged with the responsibility of beating the performance of their benchmark, a task that statistics suggest they’re more likely to fail than achieve.
Also, picking actively managed funds can be costly. You can expect to pay on average 1.13% a year.
If you decide you don’t have enough experience, or you would rather spend less time researching companies and worrying about your diversified investment portfolio, this is probably the simplest route.
Passive funds, also known as index or stock market trackers, replicate the returns of a stock market like the FTSE 100. Passive funds are also available for many other asset classes including, bonds, commodities, and property.
In terms of diversification, passive funds probably offer the best option by a healthy margin. With a single stock or bond portfolio you are not likely to hold even 100 investments. Compare this to active funds, and they will not own the entire market they are trying to outperform. On the other hand, passive funds own the entire market they replicate - a big tick for diversification.
A second victory for passive funds is cost. They’re typically cheaper than active funds, and can be as cheap as 0.15% a year. This might not mean a lot for many first-time investors, but over the long-term, this difference of cost, even tiny, will add up and seriously affect your returns. So, make sure you keep an eye on what you pay.
The third and final reason why some investors like passive funds is because as previously highlighted, it’s hard for active fund managers to beat the wider market on a consistent long-term basis. Passive funds don’t try and perform better, they’re aiming to achieve the average market return minus a tiny fee for managing the basket of investments.
Great, you’ve constructed your portfolio and now you can put your feet up and forget about it, right? You could do this but managing an investment portfolio is a bit like cultivating a garden, and to be successful you need to do regular pruning - perhaps not daily but at least quarterly. Pruning in the investment world is more commonly known as re-balancing.
Just because an investment made it into your portfolio initially doesn’t necessarily mean that it still deserves to make the cut months or years down the line. As well as regular reviewing, another crucial part of re-balancing is to ensure that your asset allocation isn’t drifting too much.
For example, imagine you had a simple 50/50 split between shares and bonds, but over time, this split drifted to 70/30 due to superior performance of the shares in your investment plan. Your asset allocation is now drastically different to the one you previously set. Yes, it might be due to strong performance, which is great, however, instead of looking like a confident investor you now have an investment plan that now has a higher risk level given the increased level of stock exposure. And typically, you’ll likely have to buy and sell some investments to re-balance the portfolio back to the weights you initially set.
But this isn’t the only reason for ongoing monitoring and re-balancing. Should the investment story change with time and adjustment to your asset allocation may be required. A topical point would be the implications of Brexit on the UK stock market. A newly elected Prime Minister (PM) with what appears to be very different views and beliefs to the departed PM may have an impact on your investment plan.
If that all sounds alarming, don’t worry there are other options
If you don’t want to build and manage your own investment portfolio, or just don’t have the time to do it all by yourself, don’t worry there are providers that will do the heavy lifting for you. Companies like Wealthify are a ‘do it for you’ type of investment service.
A team of investment experts will spend their days analysing stock markets, trading, and monitoring global events, like Brexit, to determine whether re-balancing is needed. For a small, modest fee, you have a team of qualified, and experienced investment professionals armed with a full working day and world-class systems to ensure they’re delivering the best investment portfolio they can.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.