Portfolio construction is like any other task, whether that be assembling those flat-pack drawers or deciding which route to take to an unfamiliar location – planning is key. While these tasks can be straightforward to plan, thanks to handy instructions and Google maps, planning the construction of an investment portfolio can be a little more daunting, especially if you have not had experience of doing so.
The most difficult part can often be knowing where to start. Here I discuss some of the key factors to consider, which should help to give some clarity.
Risk attitude
Establishing the level of risk you are willing to take is one of the key building blocks of constructing a suitable portfolio. But how do you do this? And what risks will you be taking? A good financial planner will establish your risk profile using incisive questioning skills along with helpful tools such as a risk questionnaire. They will seek to establish how you react to events that occur when you invest money, for example the value of your investments rising and falling. Furthermore, they will also gather information on your wider asset base to establish if you in fact have the capacity and can afford to take on an investment. There are a number of risks involved in investing money but the one most people are likely to be familiar with is ‘capital risk’ – the potential for loss of part (or all) of an investment. Risk and reward are intrinsically linked and establishing your ‘risk appetite’ is essential to ensuring you invest in a way that best suits you.
Timescale
What is your ‘investment time horizon’? In other words, how long can you invest your money before you need to spend it? This is so important to establish as the longer you can stay invested, the more time you have to ‘ride out’ fluctuations in value. For instance, if you had a sum of money available right now but planned to change your car or carry out home improvements in the next 12 months, it would not be sensible to invest that money in assets which could fall in value over the short term. When investing in assets like equities (stocks and shares), it is wise to take a longer-term view and so consideration should be given to making sure you have an appropriate amount of time available to do so.
Income or growth (or both)?
It is worth asking yourself, ‘what am I trying to achieve?’ Do you want your initial investment (the capital) to grow or are you looking to invest for income? How would you know? During the ‘accumulation’ stage of your investing life, you may wish to focus on capital appreciation. An example of this could be to build a retirement pot to maximise what you can draw from it when you stop working. If this is your focus, your investments may include assets aimed at achieving capital growth, such as equities. Later, when you begin drawing from your investments, you may wish to have an income focus aimed at providing you with an income stream and could involve investing in income producing assets such as property. These focuses need not be exclusive to one another, and your portfolio could be constructed to include both. However, it is worth giving thought to which, if any, you have a preference for.
Diversification
The benefits of diversification are well documented, with the concept being that by building a portfolio which invests across multiple asset classes and geographical locations (the four main asset classes being equities, bonds, property, and cash), consistent long-term returns can be achieved while providing protection against the underperformance of specific asset classes or geographic regions. Returns generated by the different asset classes are generally (but not always) uncorrelated. The main downside to using diversification within your portfolio is that you will not benefit as much as you might have from strong performance of a specific asset class or geographic region had you chosen to invest solely in one of these. Again, it comes down to a question of risk and reward.
Sustainability and/or ethical investing
It is important to consider your personal beliefs before investing and whether you would like to invest in a way that explicitly acknowledges the relevance of environmental, social and governance factors. Mattioli Woods offers a range of options for investors in the sustainable/ethical space. If there are areas in which you wish to avoid investing, which may include global concerns such as human rights abuse and military, and everyday concerns, such as alcohol or tobacco, Mattioli Woods offer a range of ethical portfolios across the risk spectrum. If you are interested in achieving positive social and environmental change as well as strong risk adjusted returns, we offer the Responsible Equity Fund. This Fund invests in a broad range of companies that are aligned meaningfully with one or more of the United Nation’s Sustainable Development Goals. Given the increasing amount of industry and academic research which indicates that there is a relationship between environmental, social and governance factors and financial performance[1], this is an area where Mattioli Woods are well resourced and continue to advance.
Tax implications
The tax implications of making an investment should always be taken into consideration. After all, what is the point in making an investment gain if you then have to pay it all back to the taxman? There are a number of ways you can structure your investment planning to maximise the tax efficiency of your portfolio. This could be by investing via ‘tax wrappers’ such as pensions and individual savings accounts (ISAs) which ‘shield’ your investments from various forms of taxation, as well as making use of the available tax-free allowances including the personal allowance, personal savings allowance, capital gains tax annual exemption amount and the dividend allowance. There are also other tax incentivised investment opportunities you may wish to explore such as Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs). Tax should not be the primary driver for making an investment, however, good financial planning should always take into account the potential tax consequences of an investment before it is made.
[1] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1964011
