Lesson five: Building an investment portfolio

What is an investment portfolio?

Your investment portfolio is simply a collection of your different investments. In the past a portfolio was often a big ol’ folder full of paper share certificates, but nowadays your portfolio is usually held in an online account that you log in to in the same way as a bank account.

Asset allocation – your mix of different investments

Before you can build an investment portfolio, the first step is to decide on an asset allocation. All it means is how you spread your money across different investments. So what proportion of your money will you keep in shares, bonds, property or cash? How will you spread your money between the UK, Europe and the rest of the world?

Asset allocation can have a big impact on how well or not well your portfolio performs. In fact, it’s likely to make more of a difference to your overall returns than your choice of individual investments. Famous academic research has shown that it is responsible for 90% of the differences in investment returns*.

You can find more information about the different types of investments in lesson four.

Deciding the right asset allocation for you

 As with most big decisions, you need to think about a few things to decide what’s right for you, such as:

• How much risk you’re comfortable taking
• How much money you can afford to lose (should it happen, you need to still be financially stable)
• How long you can leave your money invested (usually, the longer the better)
• How much investment growth you would be happy with (we all want to earn big on the stock market but, y’know, realistically what are you looking for?)
• How much you want to lose – this might sound a bit daft as no one really wants to lose money. But investing always has the risk of loss so you need to be realistic about how much you want to lose, even if you can afford it

Risk and reward

When it comes to investing there’s usually a strong relationship between risk and reward. For example, investments considered riskier, such as shares, have historically given people much higher returns than less risky investments, such as Government bonds.

Obviously, there’s no guarantee that shares will definitely make you more money – otherwise they wouldn’t be risky! This is why you need to think about how much risk you’re happy to take and how much money you want to try make.

The impact of time

When you’re having a great time thinking about investment risk *cough* it’s also important to think about how long you’re investing for. This is known as your time horizon. Generally, the longer you plan to stay invested, the more risk you can take. This is because you have more time to ride out the ups and downs of the market with less chance of having to withdraw your money when your investments are at a low point.

You can find out more about the impact of time on investments in our lesson.

What does diversification mean?

Diversification is an important part of asset allocation. Spreading your money across different types of investments, such as bonds, cash, shares, and between different sectors in the world, UK, US, Europe, means you are less susceptible to falls in the market. You know how it goes ‘you shouldn’t keep all of your eggs in one basket’…

A diverse portfolio is considered less risky because different investments and markets in different geographical areas behave differently – usually they don’t move up and down at the same time.

If you think researching and picking dozens of individual investments sounds like a lot of hard work, you’re dead on the money. It’s why many people choose to invest through funds, where a fund manager does the leg work for you.

3 ways to choose your investments

Once you have decided where you want to put your money and how much of it, you will need to pick your investments. To put it bluntly, there are thousands to choose from. Luckily, you have several options for narrowing down the list and finding those that would be best for you.

1. Use an Investment search tool

Most investment companies will have an investment search on their website that you can use to narrow down your choices. You will usually be able to search for a particular investment or company name, as well as filter by investment type, geographical region, performance and charges.

2. Look at lists of rated funds

Many companies also produce lists of ‘rated’ funds that you can use for inspiration – they’re the funds that the company’s analysts believe are the most likely to do well. Check out The Best™ Funds List**; it’s got a complete list of our rated funds from every sector across the world.

3. Invest in a Ready-made Portfolio

By far the easiest option is to choose a Ready-made Portfolio that’s created and looked after by professionals. At Bestinvest our ranges of Ready-made Portfolios give you an easy way to invest. Each one is designed for a different type of investor. Bet you’re wondering which one you are now…

Do I need to review my investment portfolio?

(Unfortunately) The work doesn’t stop once you have created your portfolio – it’s important to review it every so often as the fortunes of your investments can change over time.

Your personal circumstances might also change. You may receive a humungous pay rise (here’s to hoping, right?) and decide that you can afford to take a lot more risk with your investments.

It perhaps goes without saying that over time different areas of your portfolio will do better or worse than others. These differences in performance can actually cause your asset allocation to shift gradually, as certain investments grow more quickly than others and take up a bigger portion of the overall portfolio.

It’s a good idea to ‘rebalance’ your portfolio every six months or so. This just means selling some of your current investments and putting the money back into other types of investments to bring your portfolio back in line with how you originally placed your money (your asset allocation).

* Brinson, Hood & Beebower (1986); Ibbotson & Kaplan (2000)

** The Best™ Funds List is a trademark of Bestinvest