We are now officially in Spring, a time of year when the dark Winter months are behind us, gardeners start planting bulbs and traditionally many people give their homes a thorough clear up. Yet it isn’t just homes that might require a top to bottom de-clutter – investors should also consider doing the same with their portfolios.
Spring of course coincides with the final weeks of the tax year, when many people are busy thinking about using important allowances, such as ISAs and pensions, before the tax year-end deadline. Yet last minute investing carries potential pitfalls, chief of which is making hasty investment decisions and getting swayed by whatever investment themes are currently in vogue.
Right now that might include jumping on the US equity bandwagon, with all the noise about Donald Trump’s planned tax cuts and infrastructure spending.
There is a tendency amongst private investors to select investments at this time of year on an ad hoc basis, getting drawn in by expert tips, the latest high profile fund launch or whatever happens to be riding high in the performance tables. Such an approach means that over time they can end up accumulating sprawling collections of once fashionable funds rather than a well-planned portfolio that is structured to meet their long-term goals.
So, before investing new money into these near record high markets, I would urge investors to first of all get out their metaphorical investment feather-dusters and review their existing portfolios. This will help drive much better informed decisions about where to invest further.
There are three key phases to doing this effectively:
Affirm your goals
Firstly, it is important to reaffirm your goals, time horizon and attitude to risk. Most people invest for a reason, not as an abstract hobby. That could be to pay off a mortgage, finance their children’s education or fund retirement. There is usually some form of time horizon involved and as the years pass, timelines typically narrow or circumstances change from when a saver first began their investment journey.
It really does make sense to stand back periodically and ask yourself what you are trying to achieve e.g. preserving the value of what you have, capital growth or the generation of income? And it is also important to ask yourself how much risk you are prepared to tolerate from here onwards.
Of course when markets are buoyant and investors have been enjoying strong returns, it is easy to absorb the optimism and declare yourself to be an “adventurous investor”, but the right way to think about risk is: what level of potential losses could I tolerate over the short to medium term?
Secondly, it is essential to understand what your asset allocation is, where it needs to be and have a conscious strategy in place. Asset allocation means how your investment cake is divided up between different categories of investments such as shares (equities), bonds, property, cash and the like, as well as how it is spread across different geographies and industries. Asset allocation will help determine the level of risk you are exposed to, as diversification can help reduce being overexposed to a big setback in any one area, but also the breadth of potential opportunities available. Investors with very long time horizons ahead of them should be prepared to tolerate greater risk, for example by having high exposure to equities including more volatile areas such as emerging markets, while those with shorter time horizons will need to have higher exposure to less erratic types of investments such as shorter-dated bonds, absolute returns funds or cash.
Investors must review their asset allocation periodically, as even an initially well-balanced and carefully crafted portfolio will naturally drift over time as not all markets move in tandem. This is particularly the case over the last year where the falling Pound means that many UK investors will have seen their exposure to overseas markets rise dramatically. A portfolio will therefore need to be rebalanced at least annually either through trimming and switching exposure to areas that have become too large a part of the portfolio or through using any new cash being invested to top-up areas that deserve greater exposure.
Review your funds or shares
Thirdly, the quality of the underlying funds or shares held need to be reviewed. Many investors who make their own decisions skip the first two steps above entirely to focus exclusively on picking specific investments and in this respect they are not helped by the fact that a lot of the services for such types of investors bombard their clients with fund ideas but provide few tools to help them understand where they are invested and the importance of asset allocation.
But even credible fund ideas can flounder over time as circumstances change, such as the resignation or retirement of key personnel or a fund becoming too large and unwieldy. It is therefore vital to keep a beady eye on the individual investments owned, especially when it comes to “actively managed” funds but even index-tracker funds, which are designed to passively shadow overall market movements, should not be immune from periodic review as a price war between providers may mean you could shave some costs by switching a holding to a more fee competitive rival with an almost identical strategy.
A very useful personal discipline is to set yourself a maximum number of holdings, to avoid the natural tendency to always add yet more funds to a portfolio. For fund and investment trust-focused investors, my view is that 20 holdings is about as many as even a large portfolio needs. Setting such a cap means that when you are tempted to invest in something new, you force yourself to carefully consider how it measures up against those you already own and whether any of these should make way for it. If you remain convinced in your existing line-up of funds, then top these up further.
There is no need to rush
If all this sounds like a lot of work for someone to do when they are trying to beat the tax year deadline, it is important to understand that the deadline is simply to secure the allowance and there really is no rush to put your cash into the markets.
It is much better to open your ISA or make a contribution to your pension with cash before the tax year end and then take the appropriate time to consider the right places for you to invest it after the tax-year end melee has calmed down, than to make a quick decision that you may later regret or might not be the right one.
Indeed, even where an investor is confident they know where they wish to invest, funding an allowance with cash and then drip feeding it into the markets over a period of weeks and months, is a very sensible approach as it may help smooth out the potential impact of daily market ups and downs.