For many people, an investment will mean buying shares in the stock market. However, investments cover everything from shares, bonds, gilts and property through to vintage cars, wine and art. There are of course risks associated with investing in anything, but some investments are seen as a lot riskier than others. An investment portfolio will help your money work harder for you and is often designed to spread this risk (although it should be noted, it is not without risk).
In this guide we’re going to look at how to build an investment portfolio in order to maximise returns on your hard earned savings.
What is an Investment?
An investment is clearly very different to putting aside money in a bank or building society account. Essentially, it is a gamble with the risk of losing money; potentially a lot of money. When you invest, you trade off the security of a guaranteed smaller return on a savings account for the chance of far greater returns from investments.
There is, however, a risk that you may not make any profit at all, or that you will suffer a loss. UK bank and building society accounts currently offer very poor rates of interest but are backed by the Financial Services Compensation Scheme meaning that if the institution fails and cannot repay your money, you are guaranteed compensation up to a current limit of £85,000 per person per institution.
How do I create an Investment Portfolio?
An investment portfolio provides the possibility of greater returns. Interest rates on savings accounts are currently below inflation meaning that if you keep all of your money in a bank or building society, its value in real terms will decrease over time. A well designed portfolio spreads the risks inherent in investment and increases the possibility of profit.
One of the most important considerations in managing risk and maximising potential gains is to have a diverse portfolio covering several different types of investments, or ‘asset classes’. Most investors will consider cash, shares (equities) and bonds. Historically equities have provided the greatest gains but they are risky.
The value of shares can decline drastically if the company does not perform to the level the market expects. Bonds are safer but usually provide lower returns. With bonds the investor buys debt issued by the Government which is paid back at a set rate, offering a fixed income.
A further investment option is a fund, which is a managed approach to investing in the stock market. Instead of buying your own basket of shares, you buy units in a fund which provides a pool of money for the fund manager to invest in the stock market. The fund manager will manage the fund in accordance with the aims of that particular fund, buying and selling shares as necessary. Some funds track the stock market as a whole whilst others invest around a particular theme. Different funds will involve different levels of risk.
A balanced, diverse portfolio will usually consist of a combination of cash, equities and bonds. The balance between the asset classes will depend upon the investor’s end goals, appetite for risk and time frame. Those looking to invest for the longer term may be willing to take greater levels of risk than those wishing to build up and maintain retirement funds or pay school fees.
It is vital to review your portfolio as your needs and attitude to risk change over time. As you age, you will want to reduce the level of exposure to high risk investments. However, the need to rebalance your portfolio needs to be weighed against the fact that every time you buy or sell an investment, you will incur fees. Investments should be considered as a long term commitment.
What are the Likely Returns on Investments?
As a general principle, the more risk you take, the greater the possibility of both bigger returns and bigger losses. Equities are more volatile than bonds, with greater increases and decreases in value. You should fully appreciate the risks of the investments you choose and be prepared to accept that the value of your investments could fall as well as rise.
Getting Professional Advice.
Investors will usually require advice on creating and managing their portfolios. Don’t be tempted to act on the advice of family and friends; advice from a wealth management professional is strongly recommended.
Wealth management advice will cover the appropriate mix of investments taking into account your needs to conserve capital and create growth and your own attitude to risk, as well as your age. Understanding the complexities of different investment products can be a minefield without expert advice.