When investing, you can never guarantee the returns you might get, but there are things you can do to boost the potential for a positive outcome. Here are eight guiding principles that could help manage your risk and improve your chances of achieving reliable long-term returns.
1. Have a plan
Thinking carefully about your purpose for investing can help enormously when deciding which investment strategy is right for you. There are three key questions you should ask yourself here:
What is your goal and target?
For example, you might want £40,000 for a deposit on a home, or £200,000 to add to your retirement income.
What is your timeframe?
You might need to amass your £40,000 deposit in five years, or you could have 30 years or more to build up your retirement fund.
How much risk do you want to take?
It’s quite common that investors will accept more risk in return for more reward when they are investing for a long time or with smaller amounts. Which brings us neatly to…
2. Understand your risk and reward
As a general rule of thumb, investments that have higher risk usually have the potential for higher rates of return (reward), while low risk is more likely to give you a lower return. So, individuals looking to significantly increase the value of their investments, who are prepared for the fact the value of their investments may also go down, are more likely to choose to invest in assets that have high risk.
Understanding risk means identifying your own attitudes towards it and knowing what level of risk you want to take with your investments. We’d all pick the ‘high return, low risk, fast exit’ option if it were on offer, but quite frankly it’s not.
A low-risk investment portfolio will tend to be weighted towards bonds, perhaps as much as 80%, while a high-risk portfolio would typically contain mostly equities (company stocks) – as much as 95%.
Picking just one or even a handful of company shares can be a very high-risk approach as it means you have all your eggs in one basket. If a company you’ve invested in hits hard times, it could leave your investments in tatters. At Nutmeg, we build investment portfolios that are strategically spread across many currencies, countries and industries to counter this. Even our small-value portfolios typically hold thousands of individual securities.
Over time, some investments in your portfolio will perform better than others. While it’s tempting to buy more of the investments that are giving you the higher returns (and human instinct can be a wilful beast) this will give you a portfolio that is out of sync with your original plan and the amount of risk you want to take.
This can cause havoc with your portfolio. So you should in fact do the opposite. This is called rebalancing. Rebalancing involves buying and selling assets within a portfolio to retain the right proportion – or ‘weighting’ – of different assets in the portfolio, to match your objectives.
5. Focus on fees
Over time, inflated investment fees could have a monumental impact on your net returns. If you’re managing your own portfolio via a platform then you’ll probably be paying commission fees as and when you trade. These can add up. You might be paying over the odds on any fund management costs too. And be careful of any set up charges or exit penalties.
It’s prudent to know exactly what you’re paying and what you’re getting before you commit. Headline prices that you see advertised might not include all costs – you sometimes have to dig into the small print to really understand what’s going on.
Ah, the power of compound returns. To put it simply, this is when you earn returns on your returns. As you receive dividends and other income on your investments you can keep these invested in your portfolio so future gains are based on a higher amount. It’s an easy and effective way of growing your investment pot.
7. Max your tax allowance
In the UK we get an annual ISA allowance and an annual pension allowance. There are great tax advantages of both. Making the most of these tax breaks can really boost your chances of decent portfolio returns. In the majority of cases it’s prudent to look at investing within your ISA and pension allowances first before you look anywhere else.
8. Stick to your plan
We’ve come full circle. And rightly so. We believe that sensible investing is a long-term game and one that should be free of over-reaction or emotion.
We think it’s vital to stick to an investment plan and resist any temptation to chase faster returns on your money, take more risk than you’re comfortable with or derail your portfolio by buying investments simply because they have been recommended in the media or by a friend or colleague.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance. ISA and pension rules apply. Tax treatment depends on your individual circumstances and may be subject to change in the future.