Article

Why do I need a portfolio?

A portfolio of different investments reduces risk. With investments across varying asset classes and categories, the overall impact of market volatility tends to decrease.

| 6 min read

The future is uncertain, so investment managers constantly need to keep an eye on what could go wrong, as well as seeking out the better-performing investments. If a client wants to take the risk of buying shares, it is wise to choose a selection of companies that the manager thinks could do well, as they will not be right about all of them – but you are unlikely to be wrong about all of them too.

A well-run company with good prospects could be suddenly hit by a bad event, such as an oil spill or a factory fire, which could change its prospects for the worse overnight. Good companies can experience share price falls even when they are trading well if the mood in markets changes because fears grow that there will be a recession or other bad economic development.

To handle these types of risk it is usual to have a portfolio that has a spread of different companies, and in most cases has some investments in things other than equities as well. Some investment managers do as Charles Stanley does – and sets out possible scenarios for the future. The portfolios are mainly invested to benefit from the most likely or “base case” but will also have some investments there in case one of the less likely futures comes true, with different assets than expected doing well.

There are plenty of choices. With an equity portfolio, there is plenty of choice of sectors, types of companies and geographies. With bonds, you can decide to lend to different governments, or to companies. There is a huge choice of what rates of interest you will receive, how long you need to wait for the bond to repay, and what currency the bond is in. The investment manager’s task is to construct a portfolio for an individual considering their aims and their circumstances. The most important thing is that the client runs an appropriate level of risk for their circumstances and future goals.

What is risk?

When someone discusses the options for their savings with an investment manager, they will be asked about how much risk they can run. There are numerous ways of defining and measuring risk. At its core is the question of how much you are prepared to lose when trying to make more money than simply leaving it in a safe deposit.

A portfolio of shares over most time periods will make you more than leaving the money in the bank, but in any given year or two shares might fall away in bad markets leaving you with a loss on your valuation. Often it is right to hold on, as the shares may well recover and go on to earn the better returns you expected. If you choose the wrong shares – or even the wrong equity markets – you could be in for longer periods of loss.

Many people with savings as a result keep a portion of their savings in the safety of bank deposits. You should do this for any money you will need to cover bills and spending you know about to maintain your lifestyle. Share or more risky bond investing is a longer-term idea, for money which you do not need any time soon where you want to grow your savings for some future need or use other than your normal living costs. In many cases, you get a better long-term return if you can live with assets that go down from time to time.

In many cases, you get a better long-term return if you can live with assets that go down from time to time.

Managers will talk more about risk and how they measure it. Investment managers look at the past performance of different assets and can give indications of what has happened in past periods where shares or bonds have gone down sometimes and created losses in valuations or portfolios. Assets are rated according to historic, longer-term rates of return and by how much in any given year or other period they can go down. If someone cannot tolerate the idea of having times when their savings fall in value, they need to ask for a low-risk portfolio to limit the chances of this happening. In many cases, you get a better long-term return if you can live with assets that go down from time to time as well as trend upwards over the years.

Growth, income or value shares and assets?

There are several different styles or ways of investing a share or property portfolio. Some think it best to go for the glamorous areas which are showing plenty of growth. In recent years, technology, some industrial properties, cloud computing and other fast-growth areas have done well. In 2022, there was a major price correction in these assets.

Some think it is better to include equities and bonds that offer more income than the growth companies in portfolios. The faster-growing businesses, which typically plough more of their profits back into their businesses, pay less in dividends. Strong companies are often able to offer bonds at modest interest rates. Out-of-favour-property sectors can offer better rental incomes.

These lower-growth or struggling shares and properties can underperform, and the value will fall if dividend or rental cuts are necessary. Some favour looking for the companies and properties that have been through hard times – and may well have had to cut back on the rents demanded or the dividends paid – but are now poised to recover with prospects of faster growth after a period of bad performance. The danger here is the recovery does not materialise or is not sustained and you could even end up with a bankruptcy – in which you lose your money.

Any of these methods of investing can work well over time. These styles go in and out of fashion in the markets. All require skill in selecting the right individual shares and bonds or the right funds to provide you with the assets that will benefit.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Why do I need a portfolio?

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