Build a Balanced Portfolio - dummies

By David Stevenson

The basic building block for any investor in the UK is the humble portfolio, a long list of assets held within your stock-broking or investing account.

Think about asset classes

Portfolio thinking starts with the idea of diversification, which means including different asset classes (bonds, stocks, commodities) within one portfolio.

An asset class is a broad grouping of investment opportunities that share a number of key characteristics. All government bonds, for instance, are largely similar in structure, as are stocks or shares — ditto for commodities. These asset classes represent broad buckets (groups) of opportunities available to you as an investor.

Of course, thousands of different individual shares, bonds and investment products exist within each bucket, some of which are worth your consideration, but most of which you need to avoid with a lengthy barge pole.

Dive into a world of choice

The huge variety of asset classes and their contents means that investment life extends beyond a few big individual blue chip shares (names such as Apple or Google, BP or Exxon) or lending money to Uncle Sam through the massive US bond programme.

You have a world of choice available and you should make sure that your list of potential opportunities is long, even if your actual investment actions are relatively uncomplicated and succinct.

The key to investment success is to juggle these different buckets that comprise different asset classes in a sensible and intelligent fashion, which entails thinking long and hard about diversification. Luckily academics have done much of the heavy lifting for you and they’ve come up with some smart ideas about how you build a diversified portfolio of assets.

Dozens and dozens of different asset classes exist, but in essence you need to start with the three main groups:

  • Bonds: Includes everything from lower-risk government securities to higher-risk corporate bonds issued by so-called risky companies.

  • Equities: Includes stocks and shares. But within this simple definition is a world of different national markets (the US is the largest, followed by the UK, Europe and Japan), regional markets and even global markets (a composite of all the national markets).

    In addition, certain equity-based asset classes cut across these definitions to focus on particular sectors (energy companies, for instance) as well as themes such as value versus growth investing.

  • Alternative assets: Indicates the huge range of investment ideas that don’t quite fit in the bonds and equity buckets, from hedge funds dabbling in esoteric commodity strategies to forestry funds.

The sensible, diversified investor looks to invest in the full range of assets. No matter what your style, at the very least you need to consider investing in items from all three broad asset classes.