Eggs in Baskets: Reducing Risk From Equity Exposure
As we approach Easter, there will plenty of talk of eggs and baskets flying around. So, let’s join in from an investment perspective and imagine for a moment that, by eggs, we mean equity.
Getting into the Easter spirit, we can pose one of the great questions of asset management thus - just how many baskets should you place your equity eggs into?
Portfolio diversification is one of the great debates of wealth and investment management. There are those who, to introduce another analogy, believe wholeheartedly in backing a single horse to generate the best returns. Then there are others who take the old proverb about eggs and baskets seriously and advocate spreading your assets far and wide.
No one approach is correct, of course, and it all depends very much on the risk profile of the investor. Certainly, placing your equity eggs into a smaller number of baskets can yield greater rewards, but it’s a gamble. If things don’t go as expected, you lose everything.
So how should we best approach this fine balancing act between risk and reward? Are there certain rules to follow, should deciding on the breadth of a portfolio be based on certain characteristics of the investor?
To a certain extent, this is what wealth managers do when they complete a risk profile. But in practice, the balancing act is much more subtle than that. It isn’t a case of you have a Moderate profile, here are your baskets, you have a High Growth profile, here are yours. The reality is, good investment management requires careful, continuous attention, reevaluation and fine tuning.
Let’s take an example.
Two clients, let’s call them Fred and Irene, approached us with a portfolio they had built up themselves and acquired through inheritance. Their investments were mainly in the form of UK stocks, unit trusts and OEICs, with some foreign assets. Both in their 50s, still working full time, with a more than sufficient income and no liabilities, Fred and Irene’s question to us was straightforward - how could they maximise returns from their investments to give them a good, tax efficient income in their retirement?
From the risk profile we carried out, it was clear that Fred and Irene fell into the growth portfolio category - they were looking for high returns, and they had perhaps 10 years to secure it.
This is where Fred and Irene’s story is a good example of the complexity of factors which must be weighed when judging diversification and balance in a portfolio. Both in their 50s, Fred and Irene didn’t fit the usual profile for the young, high equity growth investor with plenty of time to ride out the troughs and peaks. Yet here they were, working, financially secure, with an existing high equity portfolio looking for strong returns over ten years. Our question was whether the balance was right to protect the sort of returns they required.
In the end, we decided there were too many eggs in the UK equity basket even for a growth portfolio. We felt that the level of risk over a relatively short span of 10 years exceeded the desired level, and some reallocation of assets would be beneficial.
Once agreed, however, this was not the end of the story for the next decade. As said, good investment management is an ongoing responsibility and requires fine tuning. We gave Fred and Irene access to on online portal where they could track the valuation of their investments in real time. And we set up an annual review, so we could review performance against expectation, see if adjustments needed to be made to the portfolio to bring it back in line with our original investment model, or whether that model was still suitable.
For example, we advised from the start that, as Fred and Irene approached retirement, the model should start to change so it reduced risk, moving towards capital preservation rather than capital growth. Nothing is set in stone in investment management. They key is finding the right baskets for your eggs at the right time.
Fiducia Wealth Management is an established, multi award winning firm of independent financial advisers providing a first class services to private clients, business owners, family estates, charities, pension funds and trustees. To find out more about our services, please visit our website www.fiduciawealth.co.uk or contact us here.
[Sponsored article by Fiducia Wealth Management]
Author: LifeTalk Admin (Bella)
Posted: Tuesday, April 04, 2017 | 8:26:27 AM