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.
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.
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.
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
In a year when Glasgow hosts the 26th UN Climate Change Conference of the Parties (COP26), now, more than ever, we are conscious of the impact of our actions, not only on the planet but on our fellow humans and investing is not immune from this. Sustainable investment has surged in recent years, with the Investment Association’s statistics showing that UK savers put almost £1 billion a month on average into responsible investment funds in 2020 . In September this year, Mattioli Woods launched our Responsible Equity Fund, giving our clients the opportunity to invest in this way with us, with the fund having the aim of investing in companies which behave in the interests of their communities and wider society. You may also consider ‘ethical’ investing, if you have areas you wish to avoid investing in, which may include global concerns such as human rights abuse and military, and everyday concerns, such as alcohol or tobacco.
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.
This article has been produced for information purposes only. It is not intended to be an invitation to buy or act upon the comments made. All investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances and one must satisfy certain investor criteria before being considered eligible to invest. Any forward-looking statements and forecasted returns represent the current views of Mattioli Woods plc and may be subject to change. Your capital may be at risk and past performance is not a guide to future returns. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority. Mattioli Woods do not provide tax advice, and you should always consult a tax specialist in these matters.