Rising inflation and the cost of living crisis might have made you look again at your cash savings. With the Consumer Price Index (CPI) at 9% for April and the base rate at just 1%, the money you hold in cash is effectively losing value in real terms.
Investment offers the possibility of inflation-beating returns, with the added risk that your fund value can fall as well as rise.
If you’re considering investing, it’s important that you have a long-term goal in mind and that you understand your attitude to risk and capacity for loss. This will help to ensure you reach your long-term goals while taking the minimum amount of risk possible.
We can work with you to build a risk-managed investment portfolio aligned to your goals. One of the ways we do this is through diversification.
What is diversification?
Diversification means building a portfolio comprised of different asset classes, across different sectors, and in different parts of the world.
When global events like Russia’s invasion of Ukraine lead to volatility in world markets, certain areas and sectors will likely be more severely affected.
By spreading your money over different investment sectors and geographical areas, we spread your exposure to risk. A fall in one area will hopefully be offset by a rise in another.
Diversifying across asset classes is vital too, as some are higher risk than others.
The main asset classes are:
- Equities – These are shares in a company that can provide you with a dividend if a company’s share price rises. Shares are considered high-risk because prices can fall as well as rise.
- Property – Tangible assets like property form their own asset class and are typically seen as higher risk.
- Cash – If you are risk-averse and not looking for long-term growth you might hold money in cash. With inflation high, however, your money could be effectively losing value in real terms.
- Bonds – Bonds are effectively a loan you make to a company or organisation from which you receive interest payments. Bonds are usually considered low risk.
Focusing on your long-term goals is the best way to achieve them. While this means cutting out the global noise of short-term volatility, we will also monitor your investments regularly to ensure they remain on track and rebalance if necessary.
The role of bonds in your portfolio as inflation rises
You might have read our article from last year: Warren Buffett says bonds are “no longer the place to be” – What does that mean for your investments? and the same points apply now.
While bonds are considered low risk, with inflation high and interest rates low, the biggest risk might be not taking enough.
When you purchase a bond, you’ll receive a payout in one of two ways:
- A lump sum at maturity
- Smaller payments over the term, normally at a fixed percentage.
Unlike with shares, you don’t have any ownership rights. This means that you won’t benefit from good company performance, but you will be shielded from volatility if the company performs badly. This is why bonds are considered lower risk.
However, in the current economic climate, the payout you receive from your fixed-rate bond could have a lower real-terms value than you expected.
It is also important to remember that low risk doesn’t mean risk-free. You can lose money investing in bonds if the issuer defaults on payments, or if you sell a bond for less than you paid for it.
At HDA, we can review your investments regularly to ensure you are still on track to reach your goal. Get in touch now if you have any concerns about the impact of high inflation on your portfolio.
3 reasons why diversification is key
Diversification in your portfolio can help to:
1. Minimise risk and increase potential returns
Diversification spreads risk, helping you to limit the impact of market volatility on your investment. When one sector, asset class, or geographical area falls, it is hoped that a rise in another area will help to offset the loss.
2. Provide greater opportunity for returns and eliminate investment biases
It’s possible to fall foul of investment biases but diversification can help.
We might, for example, be overly confident about the performance of sectors we know, or geographical regions that we are familiar with. These unconscious biases could see you miss out on potential growth, whereas a diversified portfolio won’t be constrained.
3. Help you to consolidate gains
As your investment goal approaches, you might be keen to consolidate your gains. Diversification allows you to do this by easily rebalancing, increasing the number of lower-risk assets you hold.
This should help to ensure that your money’s value doesn’t drop suddenly at the point that you need it most.
Get in touch
If you’re worried about the effects of short-term volatility on your investments, or any other aspect of your long-term financial plans, we can help. Please get in touch via email at enquiries@hda-ifa.co.uk or call 01242 514563.
Please note
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
