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How to strike the right balance when investing

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Investing is a bit like football: achieving the right asset allocation, or balance between defence and attack, is crucial. 

by Gavin Lumsden on Dec 07, 2012 at 12:41

How to strike the right balance when investing

For this week's Lolly Investor Programme I went to Wembley Stadium to finish my mini-series on football and investing.

Asset allocation – the spreading of money across different classes of investment – is crucial to good, long-term investing.

I reckon football – and the way a manager positions players on a pitch – is a useful analogy to asset allocation. In this video I explain why a 5-3-2 formation is probably the best!

You can see all the previous videos in the series on The Lolly Investor Programme page.

Welcome to The Lolly Investor Programme.

This week I’ve come to Wembley stadium to finish my theme on football and finance.

Wembley has been the scene of many great FA Cup matches and was of course where England won the World Cup in 1966.

Today I’ll show how you can create a world-class investment team to ensure you qualify for a decent pension in retirement.

What I’m talking about is asset allocation.

This is the term used to describe the way investors spread their money across different types of investment.

Or to use the football analogy it’s how you position your players on the pitch.

You see it’s not just enough to save money regularly you also have to think about where your money is invested.

If you’re new to investing you might think it’s all about buying shares in companies.

In fact shares, or equities as they are also known, are just one of five asset classes.

The others are: Bonds, or tradable loans issued by companies and governments; Property; Commodities like gold and oil; and Cash.

If you’re young and have around 30 years to go before retirement AND you don’t mind your savings swinging up and down like a bungee jumper, then you can afford to invest all your money into shares.

But if you’re older, say with 15 years to go to retirement; OR if you’re younger and just don’t have the stomach for the high risk, pure shares approach, you need to think about asset allocation.

In football terms asset allocation is simply about getting the right balance between defence and attack.

Make your team too defensive and you won’t score many goals, limiting your chances of winning trophies.

But make your team too attack minded will leave you vulnerable to a counter attack with more goals conceded and games lost than you’d like.

Let’s look at what some of the best asset allocators in investment are doing right now.

This chart compiles the positions of four top fund managers running funds that can invest across all the asset classes.

It’s a really interesting mix.

I think we can equate it to a 5-3-2 football squad formation.

Around half of their investors’ money goes into shares or equities. History tells us this is the asset class that will probably growth the most so most investors need a decent amount invested here.

Let’s make our two forwards and three midfielders our equity players.

The other half of the chart is divided between bonds, commodities and cash to provide alternative sources of growth and an element of safety when shares are not doing so well.

So let’s allocate the other five players in front of our goal keeper to bonds and gold and oil.

Let’s say our goalie represents cash.

He can play rush when stock markets improve and we can see good ways of using him.

If we go back to the shares portion again we can see it is split in two ways: around a third is allocated to the UK, with the remaining two thirds put into international shares.

Let’s say our two forwards represent the UK and the three midfielders stand for the US, Europe and Asia Pacific. These are the regions most favoured by investors outside the right now.

Let’s go back to bonds. Conventional government bonds in the developed world are expensive today so only 8% is allocated to them.

A similar amount goes to corporate bonds issued by companies.

The asset allocators we’re following are worried about inflation so have nearly a fifth of their investors’ money in index-linked government bonds. These will increase in value if inflation rises.

The threat of inflation is also why they like gold.

So that’s our 5-3-2 investment team.

A combination of five equity players up front supported by the bonds and commodities players should be a winning combination against most markets.

You don’t have to take these asset allocations too literally. The right balance of assets for you will depend on your attitude to risk and how long you intend to invest.

The important point is diversification. Spread your money around and you should avoid the worst of what the stock market can throw at you.

How do you implement this asset allocation?

If you’re a beginner investor, I suggest you look for a ‘balanced managed’ or ‘cautious managed’ fund run along these lines.

If you have already a decent amount saved you could invest in separate funds for each of these positions.

A pension plan invested in 10 funds spread across the different asset classes and regions of the world would be a sensible move.

3 comments so far. Why not have your say?

John Roycroft

Dec 07, 2012 at 15:20

As someone fairly new to DIY investing I found this very useful.

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Luckycontrarian

Dec 07, 2012 at 17:18

Great video - but it's absolutely crucial to consider the value of each asset you buy into - "Buy low and sell high" may be a cliche but it's a very valid one. It's all well and good being concerned with inflation and then buying gold and inflation-linked bonds but if these are already pricing in situations then they may not offer much value. Plus with all those different asset classes and types if you're only investing relatively small amounts the costs of obtaining this diversification could add up significantly - in my portfolio I prefer to get diversification from different equities of companies I am happy to hold for a long time to take advantage of their 'economic moats' and dividends eg commercial property via a REIT share, commodities via a mining share, oil via an oil company etc. Gold miners don't work quite so well but that's a whole other story. Granted there is correlation to the equity market but at the same time each sector performs very differently. I would love to see more of these videos so new investors don't get sucked in by sales pitches and fund manager personalities, which still happens far too often in my view.

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CLEARASMUD

Dec 14, 2012 at 11:48

I WISH TO INVEST £1000.000 I WOULD LIKE TO HEAR QUICK ANSWERS.

THERE ARE TO MANY OPTIONS AND EVERYONE HAS THEIR OWN IDEAS.

PLEASE HELP, CLEARASMUD

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