How to get the balance right in a diversified portfolio

▶ It’s not just a choice of shares or cash. Harvey Jones explains how your age and health dictate where you should put your money

If you want to invest for your longterm future successfully, you need to get the balance right. This involves building a well-diversified portfolio of investments, giving you exposure to shares, cash, bonds, property, gold and maybe a few more esoteric investments.

The complicated factor is that there is no one-size-fits-all portfolio that works for everybody. Your portfolio has to be regularly adjusted to reflect factors such as your age, health, investment goals, attitude to risk and how well your investments perform.

So a younger investor should invest primarily in growth stocks to help build a capital sum, whereas older investors may want to protect their gains and generate income for retirement.

Market conditions may also partly determine where you put your money, with many investors now avoiding risk as they fear a slowdown in 2019. Successful diversification is, therefore, both an art and science, so how you strike the right balance?

Damien Fahy, director of personal finance website Money To The Masses, says diversification may sound like an investment industry jargon but in practice it is quite simple: “It means avoid putting all your eggs in one basket.”

If you hold too much of your wealth in a single stock or fund you could suffer disproportionately if it crashes. You should also avoid leaving too much sitting in cash paying minimal interest, where its value will be eroded by inflation.

Mr Fahy says one should also reduce risk by investing across “non-correlating assets”, a slightly more complex piece of jargon.

“This means assets that do not move in the same direction at the same time, so they both rise together and crash together.”

Stock and property markets have a tendency to correlate; rising in the good times and falling when sentiment dips. You can offset this risk by investing in bonds or gold, which rise in value when investors are nervous and seeking safety.

As a general rule of thumb is – more aggressive investors will favour shares, while the cautious will lean towards bonds, gold and cash.

Mr Fahy says you also need to diversify within each asset class. “So your shares or mutual funds should invest in larger and smaller companies, different countries and regions, and a variety of sectors such as energy, financials, consumer, technology and utilities.”

This reduces risk and maximises your chances of making a positive return over the longer term, Mr Fahy says.

“Almost every asset class will have

its day in the sun, and you will be there when it does.”

He says a common mistake is to become too focused on your home market, and ignore opportunities elsewhere.

Another lapse is to do the exact opposite, and over diversify. “Too many investors end up holding multiple mutual funds that essentially do the same thing. You might as well buy a single low-cost passive exchange-traded fund that tracks the

entire market, it will be cheaper,” he says.

Another common error is to end up with a ragbag of investment plans picked up along the way. “This is a common mistake among expats, who often end up with a mis-mash of investments and dodgy offshore plans sold by opportunistic advisers and salesmen, with an overemphasis on mitigating tax,” says Mr Fahy.

Vijay Valecha, chief market analyst at Century Financial Brokers, has seen plenty of this in Dubai. “Expats are aggressively targeted with a deluge of insurance-based investment plans and offshore bonds. Many investors do not even understand what they hold while the charges are often exorbitant.”

He urges investors to shun complex investment plans that promise the moon in favour of ETFs.

“You can buy ETFs tracking almost every sector and geography, such as the US, UK, Europe and Japan, emerging markets, commodities, bonds, technology, financials, smaller companies and so on. This is an easy route to a balanced, transparent portfolio.”

Mr Valecha says too many “newbie” investors focus on the short-term, regularly chopping and changing their investments, and the trading charges eat into their profits.

He urges patience instead: “Renowned investors such as Warren Buffett got rich from buying and holding for the long term, and

ignoring shortterm movements.”

Stuart Ritchie, director of financial planning at wealth advisers AES International based in Dubai, says a common error is getting distracted by short-term market noise. “If you react to every headline you will repeatedly end up buying high and selling low, and lose focus on your overall objectives.”

A properly balanced portfolio will reflect your investment needs, not the needs of the adviser.

“Seek independent advice from a firm that does not accept commission and therefore has no conflict of interest, I would recommend using a chartered financial planner, just as you would use a chartered accountant for tax advice,” says Mr Ritchie.

New clients sometimes present with shockingly unbalanced portfolios, he says.

“We recently met one whose adviser said in 2010 that markets were expensive, and he should put all his money into cash. He was still in cash seven years later, during a period of record low savings rates and stunning stock market returns, and inflation had drastically eroded the value of his savings.”

Gordon Robertson, director of financial advisory group InvestMe Financial Services in Dubai, recently saw the exact opposite. “A new client told me he already had a diversified portfolio but when I checked I saw it was all equities, with too much concentration of risk.”

A portfolio like this might do well in a rising market, but could get hammered when shares crash.

He has also seen too many portfolios jammed with complex or illiquid investments. “I have seen portfolio bonds full of expensive structured notes. Just try and get out of those quickly and cheaply.”

Do-it-yourself investors make different mistakes, often suffering from “recency bias”, filling their portfolio with stocks or funds that have performed well in the recent past but may now be coming off the boil.

Mr Robertson says too many believe they can beat the market and outperform professional fund managers. “Yet they are simply jumping on trends and setting themselves up for a fall when the trend changes.”

While traditional advice recommends investors to move into lower risk assets such as bonds and fixed income as they grow older, Mr Robertson says this theory is dated.

“We now live longer, and often retire younger, so have to finance our retirement for a greater period. Some stock market exposure may still be necessary.”

Ultimately, the key is to stay focused. “Review your portfolio regularly, say every December. Is it too concentrated? Does it still match your risk profile? Are you saving enough?” says Mr Robertson.

You also have to avoid excessive charges. “You need to keep your entire costs, including platform fees, commissions, trading charges and underlying fund charges below 2 per cent a year, to reduce the drag on growth. ETFs are the cheapest and most efficient way to do this,” he says.

Steven Downey, chartered financial analyst candidate at Holborn Assets in Dubai, gives an example of how diversification and non-correlation work in practice.

“In 2008, during the financial crisis, the US stock market crashed 37 per cent but US bonds rose 20 per cent. If you held both, your bond gains would have partially mitigated your equity losses.”

A balanced portfolio may underperform the market when it is shooting up, but the consolation comes when it crashes.