5 Simple Steps for Investing

Tuesday, 15th December 2015 09:46 - by Lumin Wealth Management

Financial planners and investment managers, Lumin Weath Management, guide you through 5 simple steps for investing:

1. Pick your level of risk

In any single year risky assets like equities will exhibit a certain amount of variability in their market value.  If you invest in a portfolio with a 30% weighting to equities and diversify with bonds, property and other non-equity assets then you should expect to see the value of the portfolio move up or down by approximately 4-6% each year.  This isn’t a maximum but an average based on the past 10 years or so. A higher weighting to equities, say 50%, would increase this variability to more like 8-10%.  Even higher at 70% would again increase this to 12-14% with an all equity portfolio expected to move 15-20% per annum.

2.  Choose your tax wrapper

You should probably have a SIPP if you are investing for retirement. Gains and income roll up tax free and new pension freedoms mean you can control when you take money out without the need to purchase annuities. ISAs are also highly advisable with new maximum investment amounts of £15,240 per annum and all gains and income being tax free.

3.  Asset Allocate

If you have used a risk measure in 1) to work out your equity weighting you are now ready to try and diversify your portfolio with other assets. The basic idea is that you should try and find things that complement equity investments. That is, they hopefully are less risky and even have different market movements when equities fall. For example, government bonds often rise in value when equities fall and also produce a small amount of income.

There is much complicated theory around asset allocation. Our approach, in the spirit of Occam’s razor, is to demystify things and keep them simple. We suggest choosing investments from 5 other asset classes: government bonds, corporate bonds, hedge funds, property and commodities. We allocate a certain percentage of our portfolios to these based on a measure of their potential riskiness.  However a high level approach of fixing what feels right is also fine.  For example, if you have a 50% equity weighting then hold 15% each in corporate bonds and government bonds; 10% in property and 5% in each of hedge funds and commodities.

You have the choice of sticking to this long term asset allocation throughout your investing period or periodically making tactical investment calls to overweight or underweight asset classes. For example we have had a zero weight in commodities for the past 2 years. We use our proprietary LIVEST™ model to make these calls; others have equally valid approaches but they all rely on judgement. There’s no shame in not making tactical calls.

4. Keep your costs low and choose sensible investments

The investment industry spends a large amount of money advertising to try and convince you their shiny thing is better than the rest. Mostly this is nonsense. A fund with a top quartile performance one year is highly likely to be a lower quartile fund the next. Moreover, over long periods it is hard for managers to beat the benchmark they choose after fees unless it’s an easy benchmark.

Therefore the default position should be low cost index trackers. These can be either exchange traded funds or index tracking funds, such as the Legal and General Europe Fund.

However, we do believe there are good managers in certain markets who justify the higher fees. They add value to a portfolio through outperformance but also through diversification. For example Neil Woodford’s fund avoids large oil companies and finance companies which are a large part of the FTSE 100.

We would recommend looking for managers who have long term track records of decent performance. We would also advocate avoiding the more esoteric smaller companies or niche geographic locations.

If a fund sounds complicated and exciting it is probably best avoided.  

5. Decide How Frequently To Rebalance Your Portfolio

We have the resources to do this relatively frequently, in our case we think quarterly is enough.  If highly dramatic things occur in markets we may selectively do things intra-quarter but this is less usual.  For most portfolios annually is probably enough.   The idea of rebalancing is to bring your portfolio back to its long term asset allocation and review the performance of your managed funds.  That is, if equities have risen 10% over the year such that your 50% allocation is 55%, consider selling the equities back down to 50% and reinvesting the proceeds in your other asset classes.

An example of a diversified 50% equity portfolio:

Written by Lumin Wealth Management

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.