If you have any interest at all in financial well-being and security, you’ve probably heard the advice many times that you need to invest your savings.

And you probably also know that just as some investments can reap huge profits over time, others go badly wrong and even wipe out your savings entirely.

Why Invest at All?

Knowing that investment can be a very risky business, it’s tempting to think it might be safer to just forgo the chance of investment returns and simply hold on to what you’ve got. To avoid investment risk entirely and just keep your money in cash, in the bank.

But this is not a great option.

True, so long as your bank doesn’t go bust, the dollar value of your savings won’t go down. But over time, inflation will eat away at your money’s real value, allowing you to buy less and less with it.

So what’s to do?

Just as you need a home to live, you need somewhere to put your money. But where? And what sort of ‘place’ should you be looking for?

Fundamental Principles of Safe Investment

Thinking about building an investment portfolio as if it were a bricks and mortar building is a useful analogy.

If you’re building a home, one of the most important risk factors to take into account is weather.

When you think about it, adverse weather conditions have perhaps the greatest power to destroy or lower the value of your home:

lightning, bushfire, typhoons, floods, freak hail storms, prolonged spells of extreme heat and drought.

Even with modern technology, we’re unable to predict adverse weather events far enough in advance to do anything about them. So, when we build, we need to choose our site, materials and design with care. We need to lay strong foundations and create a structure sturdy enough to withstand unpredictable and unusual weather conditions.

Your investment portfolio derives its value and earnings from the national and global economies. Just like the weather, these economies are prone to big swings and are notoriously unpredictable.

Even the best financial forecasters only get things right occasionally and will freely admit they can’t predict much of what happens. Worse still – unlike weather forecasters – economists and other financial forecasters rarely agree with each other. So, you never know whom to trust when it comes to economic predictions.

The COVID-19 crisis is good example of how unpredictable global economies can be. At the start of the year, many of the world’s stock markets were riding high. But as investors panicked with the news of the pandemic, the value of shares plunged, wiping trillions of dollars off everyone’s holdings.

In December of last year – NO ONE could have predicted this crisis with any certainty whatsoever.

And so, to construct a good investment portfolio, you need to build with a view to withstanding many types of economic risk, as far as possible – some predictable, some not.

With a carefully built portfolio based on sound foundations, you have a much better chance of weathering financial storms.
Investment principles.

The foundations of a strong portfolio rely on four key ‘pillars’ or investment principles.

Quality, Value, Diversity and Time.

Each of these pillars are equally important. Overlook just one and you are exposing yourself to too much risk.
Let’s look at each briefly, as they’re all crucial to your investing success…

Quality

Good quality investments should have an established track record of earnings. They also need a sound basis for their operations and any expected growth. ‘Exciting’ new investments based on emerging ‘fads’ or trends offering unusually large returns would be unlikely to tick the quality box.

Investments that offer good value will provide a return that is at least as good as the market average, and ideally, better. In the case of property or bonds, you’d look at yields and compare those to opportunities elsewhere.

Note that quality and value often go hand in hand – so it’s a case of looking for a balance between the two.

Quality assets may trade at such high prices that they offer lower initial value. Or it could be that earnings expectations are sometimes too high. The key here is quality… the expectation is that they will be around for a long time, not just a ‘good time’.

Lower quality investments often appear to offer higher yields, but may carry a higher degree of risk. We all hear of get rich quick ‘opportunities’ from time to time and hopefully know to ignore them. These almost always constitute very low-quality investments.

Diversity

We’re all familiar with the saying, “don’t put all your eggs into one basket”. This is what diversifying your portfolio means.
Diversity provides a degree of protection for portfolio.

By spreading your risk, you’re reducing your exposure to mishaps. Case in point, transport, oil and leisure stocks during the COVID pandemic, which have suffered very large losses. On the other hand, some sectors have benefitted greatly at the same time, such as healthcare and supermarkets.

True diversity in a portfolio gives the investor the opportunity to take advantage of “hot stocks” or asset classes, whilst balancing out the risk with quality stocks and asset classes. It can provide a buffer against mistakes in assessing value because nobody gets it right all of the time.

A well-balanced portfolio should be designed to cope with occasional losses.

Time

Time applies to the previous three pillars. It can give you the best chance of success.

Every market will suffer periodic downturns. But the prices of most asset classes e.g. shares and property, do rise with over time, with inflation.

A golden rule of investing is to be patient and avoid short termism. In other words, don’t panic when you see values go down suddenly, and avoid trying to pick smart short-term winners for quick gains – which can lead to many needless mistakes and much higher transaction costs than necessary.

Obviously, this little article is just a quick overview. There’s a lot more to these principles than we can cover here.

Please bear in mind too, that there is no one size fits all approach to building a portfolio. Constructing a portfolio that’s right for you requires taking into account your personal circumstances and financial goals.

Would you like to talk to a professional adviser about building a quality portfolio, or managing existing investments?
Contact the House of Wealth Financial Planning Team today for a free consultation.

This article is intended as an information source only and to provide general information only. The comments, examples, words and extracts from legislation and other sources in this publication do not constitute legal advice, financial or tax advice and should not be relied upon as such. All readers should seek advice from a professional adviser regarding the application of any of the comments in this article to their particular situation.