It will depend on your personal circumstances. But some of the key considerations include:
- How (un)comfortable you are with the overall value of your investments going up and down a lot as opposed to a slow, but unremarkable, upward progress.
- What stage of life you’re at. Generally speaking, the younger you are, the more risk you can afford to take because it’s going to be a long time before you need to access the money. At the other extreme is retirement. If that’s where you are, then your risk levels ought to be very low because you probably can’t afford to lose the nest egg that you’ve built up.
- What other finances and investments you have in place. If you have a whole bunch of high-risk investments, then it might make sense to diversify and buy some lower-risk stuff.
- What you want to achieve. If you want put money aside and forget about it for 10 years, then you can afford to take a reasonable amount of risk. If you’re going to need to generate an income, next year, then the risks need to be managed much more strictly.
Key point: EVERY investment, including cash, carries risk
So let’s look at the different types of investments and the level of risk that each carries.
I always want some cash in a portfolio so that the ongoing fees and transaction costs can be met without my having to sell assets in a hurry to cover those costs. The more cash in the portfolio, the less the portfolio is affected by falls or rises in all the other asset classes. The more cautious you are, the more cash you’d be likely to want.
Inflation is very low right now, but central banks are pumping loads of new cash into the financial system with the aim of supporting the economic recovery. They have stated that they’re OK with inflation rising above the generally preferred 2% annual target, so I personally don’t want too much cash in my portfolio losing value because of inflation. Also I’m investing for at least five if not 10 years, so I want my money to work for me, not just sit there – if anyone’s going to do any sitting around, it want that to be me.
With all the nervousness that’s abounded lately, investors have bought loads and loads of low-risk rated government bonds, in particular those issued by the UK, US and German governments.
As a result, their prices have sky-rocketed, leaving them without much scope to rise further, but plenty of scope to fall over the coming five-to-10 years.
Going back a few decades, the standard allocation to government bonds would have been far higher than I have in my model portfolios because, back then, they weren’t so expensive which meant that, (i) they paid a much better annual income, (ii) they worked more effectively as a counter-balance to whatever was going on in the world of stocks.
Nowadays, generating income is incredibly difficult.
I’m focusing on “Developed Markets” i.e. North America and Western Europe) – in this allocation, I’d only put money in if I needed to be very cautious. And remember, being cautious carries its risks – if stock prices rise and the economic recovery picks up, then don’t be surprised to see government bond prices falling.
There is the choice between index-linked and nominal bonds (i.e. the ones whose return rise with inflation and those that don’t respectively). Depending on how big my pot of cash to invest is, I might invest in both, but they’re both expensive and don’t offer much of a return.
Again, I’m focusing on developed markets here.
These are also pretty expensive now, but not as bad as government bonds. I’d be looking for investment grade bonds i.e. ones issued by companies that have decent cash-flows and a fairly solid financial base.
If I were to buy bonds issued in currencies other than pounds sterling, I’d seriously consider getting them hedged i.e. with a strap-on (ahem) that offsets any changes in the pound relative to the dollar or euro. That would reduce the returns but give me one less thing to worry about. And I write this, remember, in October 2020 when the pound has taken a battering and could recover if things improve with Brexit and the pandemic. Nothing’s guaranteed, but I’d just rather not have to worry about currency changes.
This is one of the many areas in which the range of investments can overwhelm. I’d be looking for investment grade bonds issued in dollars by rock solid governments or companies, and I’d prefer to have them hedged to offset the movements in currency.
Equity or Stocks or Shares
This is actually relatively straight forward because I’m not going to get too complicated with it. I like the FTSE All Share Index because that gives me a broad spread of UK companies and is in pounds sterling and has plenty of cheap tracker funds to choose from.
For international stocks, I’d currently be considering stocks in the US because I think they’ve got a fairly decent outlook, especially with more government spending likely in 2021 regardless of who wins the election.
But the big tech companies have done incredibly well and, as a result, pushed the S&P 500 up higher than I think is appropriate. So I’m more inclined to the Russell 2000, a broader selection of companies that includes the smaller ones that haven’t done so well during the lockdown. But I’d possibly also include a bit of S&P 500 as well just to make sure I didn’t miss out too much on general gains.
I might also include some global non-UK stocks, perhaps something that focuses on large, stable companies in, say, Japan and Australia.
I’ve not mentioned Continental European stocks because I’m finding them hard to fathom at the moment: Lots of different countries with different needs and political systems but all affected by decisions from Brussels and Frankfurt. Too complex for me right now.
This is everything else. While it covers a broad range of investment opportunities, I’d limit it to a relatively small allocation to act as a diversifier. What this means is that when stock prices go up, bond prices tend to go down and vice versa. In other words, stocks and bonds are corelated.
“Other” investments, for me, are those that are not quite so correlated with stocks and bonds. In this way, when stocks and bonds are doing their dance, “other” investments do their own thing and help to offset the overall effect of the correlated parts of the portfolio.
So I’d consider gold, property and currency.
Gold is referred to as a store of value: when inflation is rising, the price of gold tends to do the same. It can also be a perceived “haven” investment much like other low-risk rated investments. That is, when folk are worried about asset prices falling, they tend to buy gold so its price goes up. The more cautious I am, the more gold I’d consider including.
But, gold pays no dividend or coupon, it just sits there, so I’d not want more than 10%, 15% if I’m really cautious.
Property is seen as attractive quite often beyond that which it merits. Retail, industrial and residential properties are all having a tough time at the moment as folk work from home more and more. The sort of property that I’d be most drawn to is warehouse stuff i.e. where the logistics, distribution and IT centres are. The demand for this property is growing, or at least not shrinking as quickly as others.
But property is illiquid i.e. it can be difficult to sell when property prices or confidence in property prices falls away. That’s why we’ve seen quite a few property funds suspend the buying or selling of their fund during times of stress this year and back in 2016. So, don’t be surprise or panicked if this happens. If that sort of risk ain’t for you, don’t buy it.
Currency is gaining in attractiveness at the moment as a counterbalance or “hedge” to falls in stock prices. Bonds are now so expensive that their hedging effectiveness is much diminished. But people do still buy dollars, yen or Swiss francs during times of stress. So I might consider a trade like that if I wanted some sort of hedge. It be a bit complex though, and if I don’t understand something I don’t buy it.