Five things to consider the next time you review your investments

24th April 2009

It has been a challenging year for investments.  Measures of success have moved away from achieving positive returns to having a portfolio which has lost less money than the rest of the market.

Reviewing your investment portfolio on a regular, at least annual, basis is essential.  In the current economic climate it becomes even more important to conduct a regular and thorough review of your holdings.  This needs to be done in the wider context of your overall financial planning, as a stand-alone review of funds can often neglect other considerations.

Here are the five main areas to consider the next time you review your investment portfolio.  The same factors apply equally to a review of your pension portfolio.

1 – How much risk are you taking with your money?

When you are investing money, you need to take risk in order to stand a chance of receiving a reward.  This is a fundamental principle of investing money.  Of course the degree of risk you take is down to you.  Any investment portfolio can be structured to have a very cautious or very adventurous risk profile, or anywhere in-between.

When we engage with new clients and review their existing investment portfolios, we often find a complete mismatch between the amount of risk they are taking with their money and their personal investment risk profile.  Sadly it is often the case that they are taking much more risk than they should be taking.

Understanding the investment risk profile of a portfolio is not simple and may require the services of a professional adviser.  However, you can get a reasonable feel for how much risk you are taking by understanding the proportion of your portfolio held in safer assets such as cash or fixed interest compared to more risky assets such as equities or property.

2 – What is your long-term asset allocation strategy?

Every investment decision you make is an asset allocation decision.  There are four main asset classes available to any investor – cash, fixed interest, equities and property.  The amount you allocate to each of these asset classes will have the biggest impact on the long-term returns generated by your investment portfolio.

Many investors make their investment decisions at fund or stock level, without consciously thinking about an asset allocation strategy.  This can be costly because returns from fund or stock selection tend to account for only tiny proportion of overall investment portfolio returns.  It is getting your asset allocation right that makes the biggest difference between success and failure.

There is another very good reason for having a long-term asset allocation strategy.  When markets are turbulent, as they have been recently, having a documented asset allocation strategy will enable you to remove some of the emotion from your investment decisions.  It allows you to make logical moves that are not dictated by what the markets are doing at that particular time.  

3 – Which fund managers should you sack and replace?

Whilst asset allocation is the most important factor, we believe it is also possible to add value through a process driven selection of fund managers. 

When you review your investment portfolio to decide on the ongoing suitability of individual funds, you need to consider more than past performance.  There might be good reason why a particular fund has delivered the returns it has over the past year.  Looking beyond past performance figures is an essential step in reviewing your portfolio because this should prevent you from switching out of funds at the wrong time.

However, if a fund is consistently underperforming compared to alternative options, do not be afraid to sack and replace it.  Most modern fund supermarket platforms make very modest charges for switching between funds.  A switching charge of 0.25% of the amount switched is typical, and time out of the market whilst the switch is taking place is minimal.  Within many pension and Investment Bond policies there are no charges for switching between funds.

Of course you always need to think about the tax consequences of a fund switch.  Also, avoiding poor performance as a reason to switch out of funds means not using good past performance as a reason to switch into funds!  Consider a whole variety of quantitative and qualitative factors including risk-adjusted returns, volatility and charges.

4 – Where are the charges going?

It costs money to invest your money.  There are typically two types of fund management charges – an initial charge when you invest the money and then an annual management charge deducted each year.  Some funds also have an exit charge for when you sell your holdings.

In the case of both initial and annual charges, these are often partially charged to pay commissions to a financial adviser.  A typical charging structure for a collective investment fund might be a 4% initial charge and a 1.5% annual management charge.  Of these, 3% commission might be paid to the financial adviser when you make the investment and then 0.5% commission is paid each and every year.

Sadly, in some instances investors continue to pay higher charges without getting a defined ongoing service from the financial adviser who recommended the investment. 

Take a careful look at the charges you are paying on your investment and understand where the money is going.  If you are not getting a good level of ongoing service from your financial adviser but you are continuing to pay them out of fund management charges, sack them and replace them with an adviser who will deliver good service.

5 – How should you measure future performance?

In a rising market, there is a fair chance that your fund might also go up in value.  When investment markets fall, funds are likely to fall as well.  The measure of success or failure in either of these situations tends to be the success of your fund relative to the performance of a given market or sector.  This ‘relative’ performance differences from ‘absolute’ performance as it also includes situations where your investment loses money.

What is important is to establish a benchmark to measure the success of your investment portfolio in the future.  Your benchmark might be ‘absolute’ (such as a 5% return each year, or a certain percentage above the interest rate available from cash) or ‘relative’ (such as the average of a particular investment sector or market index).

Having a benchmark in place allows you to carry out a meaningful review of your investment portfolio rather than simply looking at a performance figure in isolation.  Set your benchmark at the outset when you invest money and then use it each and every year to track the success (or otherwise) of your investment strategy.

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five things to consider the next time you review your investments