How do I set objectives?
The first step towards deciding what to invest in is setting your objectives. Being clear from the start what you are trying to achieve should help you tailor your investments to your personal circumstances.
There is no one correct set of investments for you, but there are certainly many wrong ways to put a portfolio together given your situation and aims.
Your objectives should take into account the what – the amount of money you need and its purpose – and the when – when you need the money and how long it must last.
However, probably the most important factor to consider is the risk you are prepared to take.
Risk is often measured in the investment industry using volatility. This measures the dispersion of returns around the mean: essentially how much they move around their average.
This isn’t necessarily what you or I would perceive as risk when running our own investments. We are more likely to be concerned with whether or not we are losing money, whether or not we are beating inflation, and whether or not we are on track for our goals.
Volatility can help us understand how likely a fund’s value is to fluctuate, but you need to take into account the other questions when putting together a portfolio.
You need to consider how likely the fund is to beat inflation – a fund could have low volatility but little chance of making 2 per cent per annum, which would ultimately result in you losing money in the current climate.
You also need to consider the potential for the fund to make money in the longer term. You will have to take more risk to get bigger gains, and this means your portfolio is probably going to vary a lot in value during its life.
In asking yourself what your attitude to risk is, you need to decide how you would react if your portfolio lost money; this is a highly personal question that depends on your individual emotional make-up.
What if you don’t see the gains you were hoping for? What if you actually see your portfolio lose value?
If you think you would react badly to losses and feel inclined to shift everything into very low-risk assets, you could end up with the worst of both worlds: a fall in the value of your portfolio and a set of funds that are likely to take a long time to even make those losses back.
Being realistic and honest is the key: it is easy to be blasé about losses before you first start seeing the real pounds and pence you have won with your hard work slip away from you as a market falls.
It may be that you have a number of different objectives and are prepared to tolerate different levels of risk with the funds set aside for each one.
Once you have worked out the risk you are prepared to take, look at your objectives again.
If you aren’t prepared to take the amount of risk necessary to give you a chance of making enough money to reach your objectives, you need to revisit your aims and rethink them.
The other variable you have is time. With more time you have the potential for better returns with a lower level of risk.
On the other hand, if you want to draw down the investment soon, you may want to reduce the risk in your portfolio, even if this is likely to leave you with less than you want.
This could be preferable to leaving open the possibility of suffering big losses at the last moment.
Each factor affects the other, which means you have to think through the possibilities.
Ultimately, you can’t define your objectives independently of considering your attitude to risk, which means taking into consideration the assets and funds that are available and how you are likely to react to their behaviour.
In a previous guide, we looked at asset allocation, which is key to setting up a portfolio with a certain level of risk.
How can I measure performance?
The future is unlikely to be as you imagined it, and neither is the future of your portfolio.
It is important to keep on top of your investments, and FE Trustnet offers many tools to allow you to do so.
Our portfolio tool allows you to chart the performance of your funds individually and as a portfolio, comparing them to benchmarks and sectors that you choose.
The portfolio scanner allows you to look at the geographical and sector exposures on your funds to see where you are actually investing your money across the portfolio.
Our rating systems allow you to follow changes in the performance and risk of the funds relative to their peers, thanks to their frequent rebalancings.
Your objectives are also likely to change. As we saw earlier, objectives are compromises between what we want and what we think we can get with an acceptable level of risk.
You may find yourself deciding to take on more risk in your portfolio if your investments aren’t proceeding as you would have liked.
Many people have had to do this over the past few years as prices rose on bond funds and yields fell, pushing them into equities.
You need to make sure you are comfortable with the extra risk involved. As we saw earlier, you need to weigh up the risk of not meeting your objectives with the risk of losing money.
When should I switch funds?
One problem many investors have is over-trading. In setting up a portfolio, you want to choose a series of funds that should give you the returns you need over the longer term.
There will be times when each fund underperforms against your expectations, and times when they outperform.
It is important not to remove a fund simply because it does badly for a year or two. You need to understand why the fund is underperforming first.
If you have chosen a fund expecting it to follow a certain strategy and it is sticking to it but the strategy is out of favour, this is not a reason to drop the fund.
Potentially, you could end up selling it just as it starts to come into favour again, and buy something that is going out of favour.
"Timing the market" – guessing what is going to do well or badly – is extremely difficult, even for the professionals, and especially for someone managing their own money with a job and a life on the side.
What you need to worry about is when a manager changes their style and starts investing differently. At this point you need to ask yourself if it’s the right thing to have in your portfolio or if you need a replacement.
This means that you need to keep an eye on more than just the performance tables.
FE Trustnet’s editorial side flags up issues we see with trends in the industry that it’s important to be aware of, while a fund’s monthly factsheet gives investors the manager’s view on what they are doing.
Beyond this, it’s also important to keep an eye on trends in the markets. In setting up your asset allocation, the idea is that you are setting yourself up for the long-term, but things can change.
