By spreading your money across a variety of asset classes that rise and fall at different times, you can avoid taking those big hits that your portfolio could otherwise suffer when one plummets. David Gow, a chartered and certified financial planner at Acumen Financial Planning in Edinburgh, gives ten asset classes to consider:
When interest rates are very low – like today’s 0.5 per cent – returns from cash accounts are pitiful, especially after tax. That said, it’s prudent to have a cash cushion to safeguard against rainy days; most advisers suggest at least three months’ salary. If the thought of losing money gives you sleepless nights, cash or “near-cash” is also the place to be. Use your tax-free cash individual savings account (Isa) allowance (£5,340 in cash in 2011-12) to boost your chances of making money in real terms.
2. GOVERNMENT BONDS
Bonds, also known as “fixed interest securities”, represent the largest asset class in the world, yet most private investors have little, if any, allocation to them.
Government bonds (known as gilts) are issued by governments to finance public spending. UK gilts are rated AAA – the highest possible – by all major credit ratings agencies. Prices fluctuate daily, depending on the outlook for interest rates, but investors who buy at par or below and hold bonds to maturity can be almost certain of a set rate of interest plus return of the principal sum invested, giving near-guaranteed returns.
3. CORPORATE BONDS
Large companies often issue corporate bonds to finance new infrastructure or pay for acquisitions. Bondholders typically receive interest every six months, as well as return of capital at the end of the term. With bond funds returning 7 per cent or more per year over the past decade, this is a good asset class for investors looking for low-risk, consistent returns and an attractive alternative to cash deposits.
Property has long been considered a potentially rewarding asset class, despite volatility over the past few years. Not only have capital values generally increased over time, but bricks and mortar have also provided a good source of income for buy-to-let investors.
Zero dividend preference shares, or “zeros” for short, are a form of split-capital investment trust. They received bad publicity during the 2000 to 2003 bear market for having high levels of borrowing and significant cross-holdings, which exacerbated their fall when stock markets sank. But these shares are attractive to higher-rate taxpayers because there is no income, and so no tax on income. Zeros come with a defined life and do not pay dividends. Instead, returns arise from the increase in their value during the term, usually between five and seven years.
Commodities, such as energy, metals and agricultural products, can play a role in a balanced asset allocation, but there are potential pitfalls. Unless you are buying a fund that takes physical possession of the underlying commodity, you won’t receive direct exposure. Instead, an exchange-traded fund tracks the price of a commodity, such as gold, silver, platinum or palladium.
7. UK EQUITIES
Following a period of poor returns from equities, there is a good bet that shares will outperform by some distance. While it might be risky to pump your portfolio full of cyclical stocks – like battered bank stocks – buying into a low-cost FTSE 100 tracker should stand you in good stead. This gives you exposure to British blue chips, many of which also benefit from a strong dividend history.
8. EUROPEAN EQUITIES
The eurozone – the world’s second largest economy – is being hit hard by the current downturn, leading to the political demise of Silvio Berlusconi, pictured, but there are plenty of reasons why it might weather the storm better than the UK and US, not least the comparatively low household debt to gross domestic product ratio.
9. NORTH AMERICAN EQUITIES
Over the long term, equities have beaten returns from all other asset classes – no more so than in the US. While the US is far from insulated from instability in global financial markets, companies in this region continue to produce earnings growth through product innovation, geographic expansion and cost control.
10. EMERGING MARKET EQUITIES
Emerging market equities – the likes of China, Japan and India, as well as up-and-coming markets, such as Africa – often prove more volatile than developed markets. However, if you’re able to stomach the ups and downs, many commentators say these markets have the best potential in coming years. Don’t bet your shirt, though: don’t hold any more than 15 per cent of your portfolio in these markets.