If in-depth research and investment expertise could tell us which asset class or individual equity was going to perform best in the year ahead then you could just put your money in that. The problem is that there is no proven way to be sure that Asset A will do better than Asset B. Investment experience and hard work can increase the probability of buying something that does well, rather than something that does not, but the ever-changing dynamics of the world means this cannot be guaranteed.
Investment managers are asked to foresee the future. They do this by using a considered review of today’s important factors combined with an understanding of the past. Research informs us of what has worked before. It tells us how well a company’s business model has performed in past economic conditions. It tells us what has previously happened if inflation gets too high or if central banks start to put up interest rates. These patterns may repeat, increasing the chances of making a decent forecast of what will happen next to specified asset classes or individual company shares.
All about risk
Investment managers are risk managers. That is why the conversation with a new client usually begins by discussing how much risk someone is willing or able to take. It is usually the case that, if you want to earn high returns, you will need to take more risks. The risk of placing your money on deposit in a reputable bank is low, especially where there is a state or insurance guarantee of the deposit. The return by way of interest paid is usually correspondingly low and will often leave you out of pocket after accounting for the impact of inflation on the spending power of your cash. The good news is even in a big share and bond market selling off the value of your deposit in pounds or dollars will not fall.
The normal view is you should be able to earn a bit better return than cash if you lend your money for longer to a reputable state or company. They raise borrowings from the market and make those loans available as tradable instruments or bonds. If you want your money back, you can sell your part of the loan to the government or company to another in the market before it matures.
A portfolio offers a way of handling risk.
If you buy a bond, the interest paid is usually higher than a deposit rate, and you will get the amount originally lent back at some stated maturity date. In the meantime, the value of your bond on the market could rise or fall depending on what is happening to interest rates and perceptions of the ability of the borrower to repay. A higher return might well come if, instead of buying bonds, you buy shares – a stake in a business where you qualify for a small share of the profits, assets and dividends.
In the case of large, quoted companies an individual shareholder usually has a tiny percentage. Here returns can more volatile. Shares may go up because the company expands its profits and pays higher dividends. They may go down because of a general economic contraction which will hit turnover and depress margins and may result in a reduction in dividend payments. Again, your share of the capital financing the company is traded on the stock market, so you can get your money back any time you like by selling to someone else.
Tailored to individual needs
Individual investors need to decide if they want the uncertainty of a portfolio of shares which can fall in value when times are hard given that, over the longer term, holding shares can lead to much better returns than the ‘safe’ bank deposit. People who do not need access to their cash to meet daily living costs or to make large purchases have more scope to take the risks of shares in the expectation that they should end up with more wealth as the companies and economies grow. Those who need their money soon should be cautious. At some point very risky investments become gambles. Putting all your money on a horse in a race – however, well you know horses – is usually seen as a gamble. Buying into cryptocurrencies in the belief that they protect you against inflation also turned out to be just a gamble in many cases, where many investors lost a lot of money in a hurry.
A portfolio offers a way of handling risk. Many people want something that offers the chance of a better return than a cash deposit, but do not want all their money at the risk of losing 20% or more in a quick-and-sharp stock market sell-off. They ask their investment manager to build a portfolio with some assets likely to hold their value in these circumstances, and some assets more capable of fast growth in good times. The portfolio also allows the investment professional to express views about risks.
Charles Stanley looks at different scenarios for the future. We invest substantial money around our most likely view or base case. We then invest some smaller parts of the portfolio around worse and better cases that could materialise. If we think economies are expanding and the outlook for the growth of profits and dividends is good, then the bulk of investment in a portfolio for a long-term investor who can afford to take risks will be in shares. The minority part of the portfolio would be in bonds and near-cash investments in case a random event like the outbreak of a pandemic or war suddenly disrupted the outlook. Where our base case is less benign, we recommend that less risk is taken whilst the economic issues are sorted out.
A portfolio is the tool to better manage risk. It is the way to try to express the views of each client on what they want from their investments. A portfolio can be designed to generate more income or more capital growth. It can be based around preferred themes in business and economic development – and can be supportive of any environmental, governance and social aims the investor may hold. It can be geared to the long term or be based around shorter-term financial needs. It can also be passed between generations. It is the flexibility of the portfolio that ensures its longevity. Portfolios are always changing, but the idea of the portfolio is the one constant in a complex world.
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.