During these difficult economic times, one of the tools available to the Bank of England to stimulate the economy is interest rates. Lower interest rates mean that it is cheaper to borrow money and people have more to spend, hopefully stimulating the economy and reducing the risk of deflation. This is why the Bank of England has aggressively cut them.
Monthly Archives: March 2012
Investment distribution bonds
Distribution bonds are intended to provide income with minimal affects on your original investment. They attempt to ensure that any tax-free returns, up to 5 per cent and usually in the form of dividends, do not greatly reduce your original investment, thereby providing the opportunity for future long-term growth. They also combine two different asset classes, equities and bonds, inside one investment wrapper.
Individual savings accounts
An Individual Savings Account (ISA) is a tax-efficient wrapper. Within an ISA you pay no capital gains tax and no further tax on the income, making it one of the most tax-efficient savings vehicles available.
Investment trusts
Investment trusts are based upon fixed amounts of capital divided into shares. This makes them closed ended, unlike the open-ended structure of unit trusts. They can be one of the easiest and most cost-effective ways to invest in the stock market. Once the capital has been divided into shares, you can purchase the shares. When an investment trust sells shares, it is not taxed on any capital gains it has made. By contrast, private investors are subject to capital gains tax when they sell shares in their own portfolio.
Investment Bonds
An investment bond is a single premium life insurance policy and is a potentially tax-efficient way of holding a range of investment funds in one place. They can be a good way of allowing you to invest in a mixture of investment funds that are managed by professional investment managers.
Open-ended investment companies
Open-ended investment companies (OEICs) are stock market-quoted collective investment schemes. Like unit trusts and investment trusts they invest in a variety of assets to generate a return for investors.
Unit trusts
Unit trusts are a collective investment that allows you to participate in a wider range of investments than can normally be achieved on your own with smaller sums of money. Pooling your money with others also reduces the risk.
Pooled investments
If you require your money to provide the potential for capital growth or income, or a combination of both, provided you are willing to accept an element of risk pooled investments could just be the solution you are looking for. A pooled investment allows you to invest in a large, professionally managed portfolio of assets with many other investors. As a result of this, the risk is reduced due to the wider spread of investments in the portfolio.
Spreading risk in your portfolio
One of the principal tenets of spreading risk in your portfolio is to diversify your investments whatever the time of year. Diversification is the process of investing in areas that have little or no relation to each other. This is called a ‘low correlation’.
Diversification helps lessen what’s known as ‘unsystematic risk’, such as reductions in the value of certain investment sectors, regions or asset types in general. But there are some events and risks that diversification cannot help with – these are referred to as ‘systemic risks’. These include interest rates, inflation, wars and recession. This is important to remember when building your portfolio.
The main ways you can diversify your portfolio
Assets
Having a mix of different asset types will spread risk because their movements are either unrelated or inversely related to each other. It’s the old adage of not putting all your eggs in one basket.
Probably the best example of this is shares, or equities, and bonds. Equities are riskier than bonds, and can provide growth in your portfolio, but, traditionally, when the value of shares begins to fall bonds begin to rise, and vice versa.
Therefore, if you mix your portfolio between equities and bonds, you’re spreading the risk because when one drops the other should rise to cushion your losses. Other asset types, such as property and commodities, move independently of each other and investment in these areas can spread risk further.
Sector
Once you’ve decided on the assets you want in your portfolio, you can diversify further by investing in different sectors, preferably those that aren’t related to each other.
For example, if the healthcare sector takes a downturn, this will not necessarily have an impact on the precious metals sector. This helps to make sure your portfolio is protected from falls in certain industries.
Geography
Investing in different regions and countries can reduce the impact of stock market movements. This means you’re not just affected by the economic conditions of one country and one government’s fiscal policies.
Many markets are not correlated with each other – if the Asian Pacific stock markets perform poorly, it doesn’t necessarily mean that the UK’s market will be negatively affected. By investing in different regions and areas, you’re spreading the risk that comes from the markets.
Developed markets such as the UK and US are not as volatile as some of those in the Far East, Middle East or Africa. Investing abroad can help you diversify, but you need to be comfortable with the levels of risk that come with them.
Company
It’s important not to invest in just one company. Spread your investments across a range of different companies.
The same can be said for bonds and property. One of the best ways to do this is via a collective investment scheme. This type of scheme invests in a portfolio of different shares, bonds, properties or currencies to spread risk around.
Beware of over-diversification
Holding too many assets might be more detrimental to your portfolio than good. If you over-diversify, you may be holding back your capacity for growth as you’ll have such small proportions of your money in different investments that you won’t see much in the way of positive results.