ASSET ALLOCATION
WHAT IS ASSET ALLOCATION?
Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one.
There are many types of “asset classes’, each with their own benefits and risks. The principle ones are:
- Cash – savings put in a bank or building society account
- Property – investors invest in a physical building, whether commercial or residential
- Shares/equities – investors buy a stake in a company (direct or pooled)
- Fixed interest securities (also called ‘bonds’) – investors loan their money to a company or government
- Commodities – a raw material or primary agricultural product that can be bought and sold
Cash Investments1
These include the following:
- Deposit accounts
- National Savings
- Term Deposits
The main benefit of a cash investment is that it provides stable, regular income through interest payments. Although it is the least risky type of investment, it is possible the value of your cash could decrease over time, even though its pound figure remains the same. This may happen if the cost of goods and services rises too quickly (also known as ‘inflation’), meaning your money buys less than it used to.
A term deposit lets you earn interest on your savings at a similar, or slightly higher, rate than a cash account (depending on the amount and term you invest for), but it also locks up your money for the duration of the ‘term’ so you can’t be tempted to spend it.
FIXED INTEREST INVESTMENTS
Essentially a fixed interest investment is a loan to a company or government for a fixed period.
– Gilts (government bonds) overseas bonds, local authority bonds and corporate bonds (loans to companies).
– Relatively low and returns predictable if held to maturity. However, traded prices can be volatile. Your money’s buying power can still be eroded over time if inflation is higher than the interest rate paid on the bond.
By investing in a government bond or corporate bond you are lending your money to help raise finance for governments or companies. Governmentsand companies sell them to investors for a fixed period of time and pay them a regular rate of interest. At the end of that period, the price of the bond is repaid to the investor.
Although bonds are considered a low-risk investment, certain types can decrease in value over time, so you could potentially get back less money than you initially paid.
Depending on the types of firms you are lending to via corporate bonds you could be taking a lower level of risk or for non investment grade corporate bonds, you may be taking a much higher level of risk.
SHARE INVESTMENTS
Shares are only known as ‘equities’.
If you own a share you own a stake in a company. Investing in a single company is high risk. Investing in a fund provides more diversification, but risk levels will depend on the type of shares in the fund.
Commonly, most people will invest in shares through collective funds. There are many reasons to invest through a fund, rather than buying assets on your own. At a basic level, investing in a fund means having a professional fund manager make investment decisions on behalf of the investor. You receive reports on the fund’s performance but have no influence on the investment choices short of removing your money from the fund and placing it elsewhere.
Spreading risk is one of the main reasons for investing through a fund. Even if you have a small amount to invest, you can have a lot of different types of assets you’re investing in – you’re diversified. You can spread risk across asset classes (such as cash, bonds, shares and property), countries and stock market sectors (such as financials, industrials or retailers). Reduced dealing costs by pooling your money can help you make savings because you’re sharing the costs. There is also less work for you, as the fund manager handles the buying, selling and collecting of dividends and income for you. But of course, there are charges for this. They also make the decisions about when to buy and sell assets.
The range of pooled investments include :
- Mutual Funds. Mutual funds are a type of open-ended investment that can include stocks, mutual funds, bonds or other investments. …
- Exchange-Traded Funds (ETFs) …
- Hedge Funds. …
- Closed-End Funds. …
- Real Estate Investment Trusts (REITs) …
- Unit Investment Trusts (UITs)–
PROPERTY INVESTMENTS
These include the following:
- Residential property such as houses and units
- Commercial property such as individual offices or office blocks
- Retail premises such as shops or hotels
- Industrial property such as warehouses
Similarly, to shares, the value of a property may rise, and you may be able to make money over the medium – to long-term by selling a property for more than you paid for it.
Prices are not guaranteed to rise though, and property can also be more difficult than other investment types to sell quickly, so it may not suit you if you need to be able to access your money easily.
COMMODITIES
Commodities are often split into two broad categories:
-Hard commodities include natural resources that must be mined or extracted—such as gold, rubber, and oil.
-Soft commodities are agricultural products or livestock—such as corn, wheat, coffee, sugar, soybeans, and pork.
RETURNS
Returns are the profit you earn from your investments. Depending on where you put your money, it could be paid in a number of different ways:
- Dividends (from shares)
- Rent (from properties)
- Interest (from cash deposits and fixed interest securities)
- Profits (increase in the underlying value of your investments)
The difference between the price you pay and the price you sell for may give rise to capital gains or losses unless held in a tax free wrapper (such as an Individual Savings Account (ISA) or your pension fund).
RISK IS THE POSSIBILITY OF LOSING SOME OR ALL OF YOUR ORIGINAL INVESTMENT. OFTEN, HIGHER-RISK INVESTMENTS OFFER THE CHANCE OF GREATER RETURNS, BUT THERE’S ALSO MORE CHANCE OF LOSING MONEY.
[1] Cash you put into UK banks or building societies (that are authorised by the Prudential Regulation Authority) is protected by the Financial Services Compensation Scheme (FSCS). The FSCS savings protection limit is £85,000 (or £170,000 for joint accounts) per authorised firm.