Spreading risk across different asset classes
Stockmarkets have historically provided investors with the best longer-term returns, although in a time of turbulent markets it can be prudent to allocate some of your investment portfolio to other types of assets such as bonds, property and commodities. Each of these have a very low correlation with equities, so when shares fall in value, there is the opportunity to have some investments continuing to grow.
Getting the right mix of assets in your portfolio can be more important than picking the very best individual funds or stocks. This is because when a portfolios weighting drift too far away from their starting point, you can rebalance the portfolio by using the additional returns from other assets. By taking the profits from one asset class, and putting them into the asset class that has dropped, you can use this strategy to make a faster recovery.
Non-equity assets are also good if you want to try and improve the returns you might receive in a cash savings account, but are unwilling to take on the risk of the equity markets.
Bonds are used by companies and Governments as a means of borrowing from investors. In return, investors receive a regular income, before getting back all their original capital at a pre-determined date in the future.
In reality, however, small private investors do not have any direct dealings with companies or Governments when it comes to investing in bonds. One way to get access to this market is by investing in a bond fund, where a professional manager will buy a portfolio of bonds on your behalf, and trade them with a view to generating you the best possible return.
In the corporate world, there are two types of bonds, investment grade and high yield (also known as junk). Investment grade bonds are those issued by larger companies with strong credit ratings, who are very unlikely to default on their repayments. As a result, they tend to pay a relatively low return. Junk bonds are those issued by companies with poorer credit ratings, and pay a much higher yield due to the higher level of risk that investors are taking on.
Governments are also very unlikely to default, hence their bonds will pay relatively lower rates of interest, with yields typically dependent on money market rates, and the rate of inflation.
Commercial property historically has also proved to have very little correlation with equity markets. Until recently, it wasn't possible to put commercial property investments into an Individual Savings Account (ISA), but changes in the rules have now increased the possibilities.
This can be a useful diversification tool to consider as part of the inclusion in a portfolio.
Levels and bases of, and reliefs from, taxation are subject to change.
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