Portfolio Net Assets: A Concern For Investors?

When it comes to investing, one of the most important considerations is the composition of your portfolio and whether it aligns with your financial goals, risk tolerance, and time horizon. A portfolio is simply a collection of financial investments, such as stocks, bonds, commodities, cash, and other assets.

The key to successful investing is diversification, which means allocating your investments across various asset classes to reduce risk and maximise returns. Different assets perform differently under various economic conditions, and by diversifying, you can protect yourself from significant losses.

It's essential to understand your risk tolerance and investment objectives before constructing your portfolio. Are you comfortable with taking on more risk for potentially higher returns, or do you prefer a more conservative approach? Additionally, consider your time horizon. If you're investing for the long term, you may be able to take on more risk, whereas short-term goals may require a more conservative approach.

By carefully considering these factors and choosing the right mix of investments, you can build a portfolio that meets your financial goals while managing risk effectively.

Risk tolerance

An investor's risk tolerance is influenced by various factors, including age, investment goals, income, future earning capacity, and the presence of other assets. For example, younger investors with a longer investment horizon may be more willing to take on higher-risk investments, as they have more time to recover from potential losses. On the other hand, investors nearing retirement age may prefer more conservative, lower-risk investments to protect their principal investment.

There are generally three types of risk tolerance: aggressive, moderate, and conservative. Aggressive investors have a higher risk tolerance and are willing to risk more money for the potential of better returns. They often invest in stocks, equity funds, and exchange-traded funds (ETFs). Moderate investors seek to balance risk and return, typically investing in a mix of stocks and bonds. Conservative investors have a lower risk tolerance and seek investments with guaranteed returns, such as bank certificates of deposit (CDs), money markets, or U.S. Treasuries.

It's important to note that risk tolerance can change over time due to age, financial situation, liquidity needs, and market conditions. Therefore, investors should regularly review and adjust their portfolios to ensure they align with their risk tolerance and financial goals.

To determine their risk tolerance, investors can take online risk assessments or consult with a financial professional. Understanding one's risk tolerance is crucial for making informed investment decisions and constructing a well-diversified portfolio that meets their financial objectives.

Time horizon

For example, a day trader has a very short-term horizon, usually measured in hours or days, while an investor saving for retirement may have a horizon of several decades. The time horizon is an important consideration when determining the appropriate level of risk for an investment portfolio.

In general, investors with longer time horizons can tolerate more risk in their portfolios since they have more time to recover from potential losses. This does not mean that long-term investors should pursue extremely risky investments, but it does allow for the inclusion of riskier assets such as mid-cap, small-cap, or high-growth stocks.

Conversely, investors with shorter time horizons should be more conservative in their investment approach to protect their capital. This is especially important for investors nearing retirement, as they want to preserve the value of their portfolio and generate stable income.

It is worth noting that time horizon is closely linked to an investor's risk tolerance, which is their ability to withstand investment losses. A longer time horizon often corresponds to a higher risk tolerance, as investors can ride out short-term market volatility and take advantage of the market's long-term growth potential.

Therefore, when constructing an investment portfolio, it is crucial to consider the time horizon to ensure it aligns with the investor's financial goals, risk tolerance, and desired level of risk.

Diversification

There are many ways to diversify a portfolio. The primary method is to buy different types of asset classes, such as stocks, bonds, real estate, or cryptocurrency. Diversification can also be achieved by purchasing investments in different countries, industries, company sizes, or term lengths for income-generating investments.

For example, an investor could purchase stakes in the iShares MSCI Japan ETF, the Vanguard Australian Government Bond Index ETF, and the iPath Bloomberg Cotton Subindex Total Return ETN. This mix of ETF shares ensures true diversification due to the specific qualities of the targeted asset classes and the transparency of the holdings.

The right mix of assets in a portfolio depends on an individual's risk tolerance, financial goals, and timeline. Most investment professionals agree that, although it does not guarantee against loss, diversification is a key component for reaching long-range financial goals while minimising risk.

The benefits of diversification include:

• Reduced portfolio risk
• Hedging against market volatility
• Potentially higher returns in the long term
• More enjoyment for investors who like to research new investments

However, there are also some drawbacks to diversification, including:

• Time consumption in managing a larger number of holdings
• Incurring more transaction fees and commissions
• Limiting gains in the short term
• May be overwhelming for newer, inexperienced investors

Asset allocation

For example, a young professional saving for retirement may opt for a higher allocation of stocks for growth potential, while a retiree might favour bonds for income and stability.

• Stocks: When you purchase a stock, you own a small piece of a company and are entitled to a share of its profits. Stocks are often riskier but can generate higher returns.
• Bonds: When you buy a bond, you loan money to a company or government, which agrees to pay you back with interest over time. Bonds are typically safer but produce lower returns.
• Cash and cash equivalents: These include savings accounts, money market funds, and certificates of deposit (CDs). They are the lowest-risk and most liquid asset class.
• Real estate: This tangible asset can generate income or long-term appreciation but is relatively illiquid.
• Commodities: Commodities are raw materials like oil, gold, and wheat. They can be volatile but offer diversification benefits.

To build a diversified portfolio, consider your goals, risk tolerance, and time horizon. You can then choose specific investments within each asset class. Remember to regularly review and rebalance your portfolio to maintain your desired asset allocation.

Investment goals

• Retirement: This is often considered the "big one". It's crucial to start investing for retirement early to take advantage of compound interest over time. Sources suggest pensions as a key source of retirement income, alongside other investments such as stocks, bonds, and real estate.
• Raising a family: This includes covering the immediate expenses of having children, as well as funding their education and other long-term costs. Options to consider are savings accounts, stocks & shares ISAs, and buy-to-let property.
• Buying a home: This is a high priority, especially in the first half of life, as it provides financial security during retirement. Lifetime ISAs and Help-to-Buy ISAs are recommended for saving towards this goal.
• Emergency fund: It's important to have a financial cushion for unexpected expenses, enforced time off work, or other crises. Aim for savings equivalent to three months' salary, with a mix of instant access savings and non-instant access savings to maximise interest.
• Career change or sabbatical: If you're planning a career change or a break, you'll need to consider the financial implications, such as training costs or a temporary drop in income. Innovative finance ISAs, peer-to-peer lending products, and a reserve of cash savings can help with this goal.
• Inheritance: You may want to leave an inheritance for your children or future generations. Unspent pension pots can now be inherited tax-free, and it's also worth considering other investments such as property, equities, bonds, or cash.

When setting investment goals, it's important to estimate the true cost of each goal and adjust them according to your financial resources, risk tolerance, and time frame. Regularly review your goals and consider setting up different accounts for each major goal to track your progress effectively.

Frequently asked questions