A five-step workout plan for investor portfolios

It is of course that time of year when after the excesses of the festive season, many of us dig out the dust covered “Fit Bit”  from the bedside cabinet drawer, hit the gyms and avoid the pubs, cut out the carbs and soldier on through endless salads and pledge to go on a booze free “dry January”, writes Jason Hollands of Tilney BestInvest.

All of this is in the hope of shedding the extra KGs put on over Christmas and New Year and getting ourselves back into shape. And of course, we end up boring each other with obsessive talk about calories, weight loss and hours spent at the gym while quietly (and desperately) willing the onset of February.

No one can seriously deny that it makes sense to look after yourself physically – the challenge is of course to keep going all year round with a regime that is sustainable rather than a short lived burst of enthusiasm. But the start of a New Year is a natural time for people to put the past behind them and set goals and aspirations for the coming year.

Review now, ahead of making tax year end investment decisions

The same is certainly true for your finances, perhaps especially so because after the festive season when most of us have focused on spending money on gifts we are confronted by a relatively short window of just over three months to utilise any unused allowances such as pensions and ISAs before the tax year end.

A common mistake when investors are confronted by a looming deadline is to make hasty decisions and get caught up in the end of tax-year frenzy, swayed by expert tips on the outlook for the year and which sectors and funds might prosper. Such an approach leads to the selection of new investments in ISAs and pensions being made as free-standing ad hoc decisions, often influenced by marketing noise or whatever is riding high in the performance tables or is being tipped as flavour of the month. Last year this was targeted absolute returns funds – many of which went on to have a disappointing run, while out of favour UK equities ended up doing well; this year there are signs of an outbreak of enthusiasm for the US on the back of the election of Donald Trump.

Build a portfolio, not a museum of investment tips

Irrespective of whether the tips turn out right or not, it is important to make sure than any new investments you make fit hand in glove with your overall strategy and existing investments: building an investment portfolio that will stand the test of time, and not end up construcing a museum of hotly tipped funds and shares.

I would go as far as to counsel investors not to invest any new money before they have first reviewed their goals and objectives, conducted a thorough health check on their existing portfolio and knocked it into shape, including a ‘detox’ of existing investments where the case for hanging on no longer stacks up. Spending a little time on this will mean better, more informed decisions on where any new monies should be invested.

A good financial adviser or wealth manager will of course be doing this with their clients on regular basis, but for those who make their own decisions, perhaps using online services such as Bestinvest, here is my five-step work out plan to get their portfolios fighting fit for the year ahead:
1. Step back and re-consider your goals

While for a few investing might be a hobby, most people do it for a reason such as providing financial security in retirement, funding children’s education or paying off a mortgage. Each of these will have a broad time horizon involved and in most cases this will narrow with each year and therefore require a periodic reassessment as to whether the investment approach and level of risk taken needs to be adapted to reflect this.

Circumstances change too with life events such as the birth of children, changes in earnings, divorce, redundancy, ill-health or the receipt of a windfall, each of which might be a trigger for a complete reassessment. It is also possible that your time horizon may need to be pushed further out if your investments simply aren’t on track with where you hoped they would be, or alternatively you might need to take on more risk to make up lost ground. The balance between cash savings and long-term investments and expected time in the market for the latter; the mix between required income and capital growth and tolerance for risk are all factors that should be considered when you mull what you are trying to achieve.

2. Optimising the right tax allowances

Future investments returns are inherently uncertain, especially on a short to medium term basis. The predictions of experts such as economists, fund managers and – dare I say it – financial advisers often end up wrong. That’s because life is full of surprises as we saw in 2016, with the vote to leave the EU and the election of Donald Trump as U.S. president. But while future market returns can be difficult, even impossible, to predict with any degree of consistent accuracy, we do know at least know how our investments might be taxed in the near term and this can make a big difference to returns.

It is therefore really wise to periodically assess whether you are making the most of the various tax allowances available, such as ISAs, pensions, your annual Capital Gains tax allowances and potentially VCTs or EIS.

Even if you have no new cash to invest, you may be able to benefit from rearranging existing investments held, for example by switching funds or savings held in a taxable environment into a pension or ISA – a process known as Bed and SIPP or Bed and ISA. And if this isn’t possible, because you are already full maximising such allowances, you might be able reduce a future capital gains tax liability by regularly using your annual capital gains allowances. Another simple, tax efficient move might be to transfer assets into the ownership of a spouse or civil partner who is in a lower tax band than you.

A top priority for those subject to the higher rates of tax should be to reassess whether they are making the right use of pensions. Pension contributions have long offered considerable attractions for those subject to the higher rates of income tax, who can get effective relief at their marginal rate meaning a £10,000 gross contribution from a 40% tax payer has a net cost of just £6,000.

Yet the future of these generous reliefs, which represent a considerable cost to the tax man’s coffers, must be in doubt as the Government has already conducted a consultation into their future. No one knows how long the current regime will remain in place but it should not be taken for granted. Those able to benefit from higher rate relief on pension contributions should seriously consider taking advantage of the current generous regime while it remains available, including potentially mopping up unused allowances from the previous three years via ‘carry forward’.

But for others who have diligently ploughed money into pensions each year, this may no longer be the right approach with a recent reduction in the lifetime allowance from £1.25 million to £1 million and the introduction of a new tapered annual allowance for high earners. There is much to consider here.
3. Review your asset allocation –  are your investments appropriately spread around?

In the world of investing, diversification across types of investments is an important way to manage risk and achieve exposure to a wide range of opportunities. How you carve up your overall pot of investments between the likes of shares, bonds, cash, property and different markets and industries is termed “asset allocation”. And with asset allocation you can either be in the driving seat, or end up with a random outcome form the individual investments you have selected over the years. The latter might leave you exposed to too much risk.

Asset allocation is really important, as each type of asset has its own risk and return characteristics, that will perform differently depending on factors such as the interest rate and economic environment. In fact academic research suggests asset allocation is a bigger driver of the difference in returns between portfolios than the specific stocks or bonds selected, so it is worth spending some time thinking about this before worrying about which funds look enticing.

Professional investors focus heavily on the process of asset allocation and adapt it tactically depending on the outlook for markets, but it is often poorly understood by many private investors who can get sucked straight into picking funds or stocks on an ad hoc basis, meaning that over time they become exposed to too much risk. Most “DIY platforms” exacerbate this behaviour by providing little in the way of help in this respect although offer lots of fund ideas.

The single biggest “asset allocation” mistake many people make is to simply hold too much cash for long periods of time, rather than putting it to work in the markets. Incredibly, despite years of historically low interest rates and a bull market in shares and bonds, cash subscriptions to ISAs have consistently vastly outweighed those into investments. While cash may be very safe, and we all need some rainy day money for emergencies and short term needs, the real value of cash is eroded over time by inflation – and inflation is starting to creep up again.

Within an investment portfolio, the core asset allocation decision is the right mix between equities, which have historically delivered the highest long term returns but with much greater short term volatility, and other less volatile assets such as bonds and and cash. The longer your investment time horizon, the greater the appetite for risk you should be prepared to take, but even a longer term growth portfolio should have some diversification across asset classes. Below the headline breakdown between broad categories of assets, investors should also think about how well diversified they are across developed and emerging equity markets, as too often UK investors are over exposed to the UK, and across different parts of the bond markets such as investment grade corporate bonds, or riskier higher yield bonds. I also believe it makes sense to consider diversification across investment approaches (active and passive) as well as styles (growth / value) since no single approach to investing is a panacea that will work well, all of the time.


4. Hit the reset button and rebalance at least once annually

Even if you carefully chose an appropriate asset allocation strategy in the past, you need to review and potentially rebalance the portfolio at least once a year. Many investors do not do this. This is because markets and asset classes don’t all move neatly in tandem, so over time your exposure to different investments will alter – often dramatically – and that means your investments may, by stealth, have drifted into an altogether different risk category from the one that is appropriate for you and which you originally chose. Rebalancing is also an important discipline for crystallising profits made in areas that have had a particularly strong run and may be getting into bubble territory and reallocating back into areas that may offer better value. In a nutshell, successful investing is about buying low, selling high – but many people do the opposite!


5. On “dry January”? Detox your portfolio as well

Alongside considering the overall mix of assets you hold, it is also important to review and challenge the individual investments you own to make sure you still have conviction in them. Circumstances change over time, so don’t get wedded to decisions you may have made in the past that are no longer right. Funds that once basked in glory may have gone to the dogs or seen a change of manager which might require a complete reappraisal of the case for continuing to hold them and potentially switching to those with better prospects.

Likewise, the costs of funds have come down in recent years, especially in the world of ‘index trackers’, so you may be able to shave off unnecessary fees by switching to a more competitive option or newer share class that have now become available.

The process of reviewing your holdings does not mean automatically ditching funds that have had a short term run of tougher performance, as this might be explained by the approach being temporarily out of favour, but it does mean understanding how they are doing and why and potentially making changes or putting them on a watch list.
Invest in 2017 armed with knowledge and a disciplined approach

Investors who have taken the time to give their investment a January workout by reassessing their goals, recognising the right tax allowances to focus on, who understand both their existing asset allocation and where they might need to move it and and are confident in the investments they already own will be in a much better position to decide where to deploy any new monies in a way that makes sense for their own circumstances.

And there really is no need to invest new money hastily, as these days it is very easy to fund an ISA or pension with a cash amount to secure the allowance before the tax year-end and then decided where to invest in later, having thought carefully about the right approach.

And the really good news is that unlike a fitness regime that should ideally be kept going throughout the year to stop the KGs creeping back on, appraising and knocking your investments into shape, need only be done once or twice a year.


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