Building an investment portfolio from scratch can be intimidating – but as long as you understand the basics such as time horizons, diversification and portfolio rebalancing, there is no reason you cannot set yourself up for investment success.
The first thing you need to do is understand your risk profile. This dictates how much of your portfolio should be invested in “risky” assets such as shares compared with traditionally safer assets such as bonds and cash.
Darius McDermott of FundCalibre, a fund rating service, says: “Often when people first invest, they tend to focus more on how much they can make rather than how much they can lose. This can lead to taking too much risk, then panic selling when markets fall, leading to a loss. Investors need to understand that periods of market downturn are inevitable and build a portfolio to match their risk tolerance.”
The more of your money you put into the stock market, the bigger the falls can be and the more time it can take for your portfolio to recover. However, if you can handle the volatility, shares should reward you in the long run.
According to analysis from the trading platform eToro, the chance of a positive return from the S&P 500 index of leading American shares rises from 72pc after one year to 95pc after 20 years.
Rob Morgan, of the wealth manager Charles Stanley, says: “The longer the time horizon for the intended investment, the more money an investor could consider allocating to shares. For instance, when investing for retirement many decades away, a portfolio mix that prioritises shares exclusively, or almost exclusively, could be considered.”
If your timeframe is five years or less, you are likely to be better off keeping your money in cash. Consider looking for a cash Isa with a decent rate so your interest can be paid tax-free.
Which funds should you invest in?
Growth assets
Mr McDermott says: “To future-proof a portfolio, we like diversified stock market funds such as JOHCM Global Opportunities. We would also suggest an allocation to bonds, which look more attractive now than they have in decades. General, flexible bond funds, such as Invesco Tactical Bond, are a good starting point.”
For cheaper options, Mr Morgan recommends an index fund such as the Vanguard FTSE All-World ETF or the Fidelity Index World fund, which have annual charges of 0.22pc and 0.12pc respectively.
“For the bond part of a portfolio there are some broad, low-cost and straightforward options such as the Vanguard Global Bond Index fund and the SPDR Bloomberg Global Aggregate Bond (Currency Hedged) ETF,” he adds.
Defensive assets
Mr McDermott says: “Taking an ‘average’ pensioner, I’d suggest a couple of global income funds that aim to grow income, such as M&G Global Dividend and Trojan Global Income, then a bond fund with a high yield such as Jupiter Strategic Bond, an alternative fund with a high yield such as Momentum Diversified Income and a global growth fund.”
Mr Morgan says: “There are also investment trusts worthy of mention, including Personal Assets, whose manager blends share ideas with ‘balancing’ assets such as bonds and gold.”
How do you build a diversified portfolio?
To understand the importance of diversification, look at the performance of Fundsmith Equity, a highly popular fund that consists of a small number of high-quality companies. Since 2010 the fund has delivered an annualised return of 15pc – an excellent figure. But it has now underperformed its benchmark index for three years in a row.
Mr Morgan says: “Different investment types tend to perform well at different times, and no one area can be on top forever, which is why it’s important to hold a mixture. Diversification also protects you from poor results from an individual company or fund manager.”
A well diversified portfolio will not be too exposed to one geographic region or sector of the economy. If, for example, your “core” fund is an index tracker that aims to mirror the performance of the S&P 500, you should also consider having some exposure to smaller and medium-sized businesses and other parts of the world.
If you want to keep things simple, you could hold one or two well diversified “core” funds – which could be index trackers – and then a selection of stocks or more concentrated funds.
Mr McDermott says: “One avenue investors can take is to opt for one of the many multi-asset funds. These funds combine different asset types, from bonds and shares to commodities and ‘private equity’ [shares in unlisted businesses], into one portfolio. We recommend the BNY Mellon Multi-Asset Balanced Fund and, for an income option, Waverton Multi-Asset Income.”
Alternatively, if you like selecting funds, you could choose 10 or so from across different sectors and regions of the world.
However, remember that holding more funds won’t necessarily mean better performance. It could increase the risk of duplication – investing in the same holding across multiple funds. It could also mean you lose track of underperforming investments.
How often should you tweak your portfolio?
Investors should review their funds regularly and ensure that managers have not recently left or retired, Mr McDermott says. Vanguard recommends that you check your portfolio every six months.
As time goes on, the proportions of the various asset types in your portfolio may need to be adjusted to match your changing risk profile. You can do this by increasing your holding of cash, for example.
Over time your portfolio will drift in favour of the best-performing assets – in recent years this might, for example, be large US stocks – so you may need to trim these holdings to bring your exposure to them back to the level you wanted at the outset.
Working out when to sell underperforming assets can be tricky. The most important thing is not to sell impulsively when one asset falls.
Ben Laidler of eToro says: “It can be tempting to cut and run when things aren’t going well with a particular investment but if the company’s fundamentals remain strong, you’re better off avoiding a hasty sale that you might later regret.”
For example, many investors abandoned Amazon after its shares fell by 53pc between November 2021 and December 2022. But over the past 10 years the company has delivered a total return of about 800pc.
