Developing portfolios

We research, construct and monitor portfolios as part of our service proposition. There are many factors we consider when we develop these and I just wanted to consider one aspect of developing portfolios and put this into the context of “DIY” investments.

“DIY” investing is being heavily promoted at the moment as the solution to not having a financial planner. This made me consider a period nearly 15 years ago when we all thought DIY was the solution to those jobs we needed doing in the house. Perhaps we could start with a little decorating but as the confidence grew we progressed to installing that kitchen we had always promised ourselves.

Of course by cutting out the builder we would save money. For some of us the end result was something to be proud off, but possible for a larger proportion the end result was a disaster which required an expert to come in and clean up the mess. The end result was that we ended up paying more by the time the mess was cleaned up.

A lot of what we read around investing is that it is easy; we can go to a direct platform and save money. The problem is that there is an element of bias on the products and solutions they promote and little guidance on goal setting. If you are going to go direct to some extent you would be better to go to a plain vanilla platform which doesn’t promote anything.

So how does this apply to portfolio construction? We regularly monitor and review the portfolios we offer to clients. One recent exercise I carried out was to look at the correlation between all the funds in the portfolios. So, by this I mean that if two funds have a correlation close to one they are likely to behave in a similar way, on the opposite side of the coin if the two funds have opposite correlations then they are going to behave differently.

This isn’t an exact science and there are other factors to consider but it helps to draw up a picture. So for example, for more cautious portfolios I would expect to see a tilt towards opposite correlations compared to more adventurous portfolios. The reason being is that you still want growth but you want to reduce the volatility and bring in an element of stability.

I am pleased to say once I had coloured in the chart the portfolios are set up as I would expect. This made me think about DIY investing, if we are sold products and funds then actually we are in danger of developing a portfolio which could be extremely high risk because we haven’t done our research, or based our research on what is shown in the sales material. If we go back to putting in that bathroom preparation is the key, we need a plan, and we need to ensure we have all the tools to deliver that plan.

To do this we need to do a lot of research and it may be that we pay a little more to do that. This approach is no different to DIY investing. If we are going to put together a portfolio of assets we need to consider the volatility of the assets when put together, the correlation between them and even something about the fund managers themselves. Once we have done the research we then need to constantly monitor and follow the funds to identify any potential changes which may impact on what we are doing.

In summary there is a place for both direct and advised investing, but if you are going direct then preparation is the key, cut through the sales material, consider your goals and the then how you will achieve these goals. And if this seems a daunting task then go and seek help.