Many investors will choose to use a financial advisor to manage and invest their money on their behalf.
If you choose to go down this route, historically your advisor would put you into one of three general buckets: cautious, balanced or aggressive.
These buckets relate to your investor style, with cautious meaning your aptitude to risk is low so you will be invested in lower-risk assets while aggressive means you have a high tolerance to risk and will be invested in higher-risk assets. Balanced, as you may have guessed, is in the middle.
Once quite a rudimentary process nowadays, this has evolved with the risk profiling done by advisors significantly improved.
“Long gone are the days when investors were simply asked if they were ‘cautious’ or ‘adventurous’,” said Tilney Investment Management managing director Jason Hollands.
“Investors will now be asked a variety of questions, including ones which confront them with the extent of potential losses they might be prepared to tolerate over a particular time scale.
He added: “This is the right approach because it is easy to believe you are adventurous when markets are soaring but it is important to go into any investment with your eyes wide open and to appreciate the potential for losses.”
However, advisors don’t come free and you have to pay for their services. If you are wanting to go it alone, then you will need to figure out yourself whether you are, broadly speaking, either a cautious, balanced or aggressive investor.
Are you cautious, balanced or aggressive?
Chelsea Financial Services managing director Darius McDermott said it is one of the critical questions you have to ask yourself before investing.
“It really does come down to potential tolerance to risk: How upset are you if you wake up and you see your portfolio down 10, 20, or 30 per cent? Because this does happen in times when stock markets correct,” he said.
Your investment time frame matters here as well. McDermott said if you have a long-term outlook, you’re not going to be worried about a market correction because you’re not going to be selling at that time, you’re going to be selling in 30 or 40 years.
If you look at the financial crisis of 2008 for example, you can see this being illustrated. The below chart shows the falls of up to 40 per cent that global equity indices endured over the space of a couple of months after the collapse of Lehman Brothers, the trigger event for the crisis.
However, it also shows that over time, the same indices have risen above and beyond where they were pre-financial crisis.
Global equity markets since 2008 financial crisis
Source: FE Analytics
“So, I think an attitude to risk and length of time are probably two of the obvious considerations for people to try and determine,” said McDermott.
Other important considerations are knowing what your investment objectives are, such as capital appreciation or income, a topic that we discussed in a previous article.
Once you have decided on your aptitude for risk, investment time frame and objectives, you should be in a position to figure out which cautious, balanced or aggressive bucket you broadly fall under.
Which assets should you be invested in?
From here, you can start to think about the sort of assets you want to be investing in and the allocations to these different assets.
Wellian Investment Solutions chief investment officer Richard Philbin said that weightings to different asset classes tend to fit with different risk-appetites.
“Historically, from an asset allocation perspective, equity assets are high risk, commodities are higher risk, cash is no risk, fixed income is lower risk and property sits between fixed income and equities,” he said. “Depending on ‘risk’, the amount exposed to equities tends to rise.”
Tilney’s Hollands noted that this fits in with investment professionals’ thinking, as an aggressive multi-asset portfolio will be heavily skewed towards equities – typically 70 per cent or more.
He added: “Within this will be included exposure to developing markets and smaller companies, whereas a cautious or balanced strategy will have equity exposure below 50 per cent.”
In a more cautious or balanced portfolio, you would typically see a higher proportion of fixed income allocations, the other main asset class beside equities.
The below table shows an example of how Hollands might typically allocate in different types of portfolios.
Tilney example portfolio allocations
Source: Tilney Investment Management
Age is a potential barometer of this, according to Wellian’s Philbin, who added that he once read a client should invest their age in fixed income (assuming they will live to 100).
“A 30-year-old should have 30 per cent in fixed income holdings (the remainder in equity), a 60-year-old should be 60 per cent invested in fixed income, a 90-year-old with 90 per cent fixed income and so on,” he said.
However, he cautioned that allocations are not always as simple as deciding how much of each asset classes you would like to be exposed to.
“Some fixed income markets can be higher risk than some equity markets. Having all your assets in one asset can be considered high risk – even if it is considered cash, a single property, a share in BP or whatnot,” said Phiblin.
“Therefore, a cautious portfolio and an aggressive portfolio can be massively contradictory.”
Something else to watch out for are the broad definitions of cautious, balanced and aggressive.
Philbin said putting people in buckets such as cautious, balanced or aggressive will mean different things for different people, which can cause issues.
Using his son as an example, he said: “If my son (12) wanted to invest and said he was cautious, but looking to not want the capital back until he was retired, then having a low allocation to equity (the ‘traditional’ way to build a cautious portfolio) would actually be a high-risk strategy.
“The utility/opportunity cost of not being 100 per cent in equity holdings (and within that high-risk equities) would not return an optimal amount for him.
“As time frames lengthen, the opportunity to put higher ‘risk’ assets into a more cautious portfolio should increase too.”
One-stop shop funds
If you’re looking for a one-stop shop fund that suits your cautious, balanced or aggressive investment profile, there are sectors in the Investment Association (IA) universe, as Chelsea’s McDermott pointed out, that classify multi-asset funds depending on their equity allocations.
They are: IA Mixed Investment 0-35% Shares, IA Mixed Investment 20-60% Shares and IA Mixed Investment 40-85% Shares.
Performance of Mixed Investment sectors over 3yrs
Source: FE Analytics
McDermott said: “The IA Mixed Investment 20-60% Shares used to be called the Cautious Managed sector and the Mixed Investment 40-85% Shares used to be called Balanced Managed. There was never an ‘aggressive’ sector but most people would be thinking equities in those scenarios.”
In the ‘0-35% Shares’ sector, funds must have between a 0-35 per cent allocation to equities, in the ‘20-60% Shares’ sector it must be between 20-60 per cent and in the ‘40-85% Shares’ sector it must be between 40-85 per cent.
Within that, they can allocate however they like in terms of taking on riskier areas of the market such as emerging and frontier equities over developed markets, or ‘safer’ areas such as government bonds over credit.
There is also another multi-asset sector similar to the above sectors called IA Flexible Investment but here the allocation to equities can be anywhere between 0 - 100 per cent so the funds within the sector will vary widely.