In investing, risk and return go together. And for the average investor, constructing a portfolio of assets that would be suitable for personal needs is not always easy.
Asset allocation can simply be defined as how you’d divide your investments among shares, bonds, bank deposits, as well as other types of investment vehicles such as real estate or physical gold. This determines your portfolio risk and returns. The aim is to strike the right balance between more potentially volatile assets such as shares and more stable ones.
Your investment horizon is important
Some investors may have relatively short-term objectives; others may be saving to make a down payment on a house; yet others may be saving long term for their golden years in retirement. Also different age groups may have different income levels as well as risk tolerance.
In general, a longer investment horizon may justify more risk-taking.
For example, investors who know that they may need a certain amount of money in less than five years tend to keep it in cash by choosing a term, fixed-deposit or high-interest savings account. In other words, cash would not be kept in currency but rather in short-term money market instruments.
And many investors may decide to put their savings that may not be needed in the next few years into equities.
Once you have decided how much of your wealth you would like to have in stocks, it is time to look at how you want to allocate your money among different types of shares.
Diversified portfolio that works for you
How many shares should you have in your equity portfolio? The answer would partly depend on the amount you have to invest and how much time you can spare to follow your shares.
If you are not a seasoned investor, it might be better to start small — you can always increase the number of shares you hold if the company performs well in the long run.
Diversification will not eliminate all the risk in your equity portfolio. But your long-run risk/return ratio is likely to be more attractive. A share portfolio constructed of different kinds of companies and sectors will, on average, yield higher returns and enable you to ride out the volatility of the stock market.
Deciding which stocks to buy can be overwhelming for both new and experienced investors alike.
For example, you could invest directly in FTSE 100 or FTSE 250 shares. For many people, investing in a dividend-paying blue-chip stock is often one of the first steps to getting started. Any capital gains delivered by the stock would be an added bonus on top of the dividend.
Another option could be to invest in low-cost exchange-traded funds (ETFs), which track popular stock indices both in the UK and globally. For example, if you are interested in dividend stocks, then the iShares UK Dividend UCITS ETF may be an ETF to consider.
The Foolish takeaway
If you’re unsure about which type of assets may suit your needs, you may want to talk to a financial adviser first before moving forward with a specific type of investment.
Although you may pay for the professional advice, an adviser would likely help you find an investment best suited for your circumstances.
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tezcang has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.