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Diversification is key when battling with the bear

When considering any investment, the investor needs to put their financial goal at the heart of their strategy. Investments are unlikely to be the right channel for short-term goals where the base value is vital. However, when you look further afield, investments, and the possibility of inflation beating returns, suddenly seem to be the better option.

In good times investments can often increase in value, but when the economy or world events take a turn for the worse you could end up losing money. It isn’t just about deciding whether or not to invest, but also about how you invest.

A robust portfolio

Modern portfolio theory looks at how you can construct a portfolio to minimise the impact of risky assets. Risk isn’t a word to fear, investment returns are directly linked to the potential risk of an asset, higher potential returns often mean higher potential losses. A strong investment portfolio is made up of a range of assets because the value of different asset classes rarely goes up and down in sync.

We are currently facing a difficult investment environment, known as a bear market. Bond yields are at a multi-year low, equities are at a multi-year high, commodities are falling, currency value is driven by a global monetary policy battle; all this contributes to increasing uncertainty in economic dynamics.

So how should the investor navigate this climate, or should they even attempt to? If an investor wants to focus on wealth appreciation and preservation a multi-asset portfolio will help them do it. In many ways the current bear market opens up the opportunity for investors to enter the market while stocks are at bargain prices. It is unclear whether the market will fall further, but spreading investments across asset classes can help to even out the bumps in the long term.

When looking at the investment menu you have the choice between equities, bonds, commodities and currencies; all this across numerous geographical areas. When considering the ingredients of a portfolio you have to look at the markets you invest in, the expected return for each market, the associated risks and the interaction between markets. This can be quite time consuming which is why you might consider a discretionary portfolio, where you let somebody else do the calculations for you.

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The portfolio composition

Each provider creates their portfolios in a different way, usually based on an investors risk profile, which may not give the investor access to the full investment menu. This is particularly common with the so-called ‘robo advisor’, Moneyfarm is a little bit different.

We think it is important to have the option to choose between all asset classes depending on the risk appetite. When selecting funds, we look for good quality providers that:

  • Manage the tracking error (how efficiently the fund tracks the predefined benchmark)
  • Have high total assets under management
  • Low fees
  • Tight bid-ask spreads (the price to buy and the price to sell).

We only use Exchange-Traded Funds (ETFs) because they have lower management costs, are cheaper to trade and still offer the full range of asset classes.

When constructing a portfolio, investors should look for the ‘efficient frontier’ which is a combination of assets that deliver the best possible returns for a given level of risk. The last part is vital, how comfortable are you with the idea that your investment may go down? At Moneyfarm we have 6 levels of risk and each level of risk assesses how an investor responds to volatility.

Diversification is vital for all investor risk appetites; it ensures portfolios are designed to weather the market storms. Our lives would be easier on a sunny day but we’re confident that a diverse portfolio can still help you to get the most out of your wealth.

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As with all investing, your capital is at risk. The value of your portfolio with Moneyfarm can go down as well as up and you may get back less than you invest.