Seven Steps to Investment Portfolio Construction

With such a wide range of funds available, selecting the right funds can be a daunting task. However, if approached with the right methodology, to this end the following strategy should assist you in selecting a well diversified, balanced investment portfolio.

1. Attitude to investment risk. Some people are, by their nature, extremely cautious who have little risk tolerance. Risk averse people who cannot accept volatility inherent with investing, should consider carefully whether they would be better suited to keeping their funds in deposit accounts or very low risk investment vehicles, such as National Savings products. You need to carefully consider your tolerance to risk. Overly investing in just one asset class will increase the overall risk of a portfolio- so diversification is key.

2. Consider any ethical factors which you feel are important to you. Our attitudinal questionnaire should assist you with this and also takes into account your attitude to investment risk. Once you have positioned yourself on the spectrum of ethical investing and of risk, we have produced examples of diversified ethical portfolios which, in conjunction with the other research modules available, should be of assistance.

3. Take into account your investment objectives. Are you investing a lump sum for income? Investing for income would suit somebody approaching retirement with a need to generate an income and needed to supplement their pension. You need to consider what level of income is required, and when you want it to begin. If an income is to be taken, do you want it to increase over time in an effort to combat inflation? If so, the capital has to grow over time. In order to do this, either not all of the ‘growth’ can be taken from the capital, or the risk of your portfolio remaining sustainable has increased.

You may be looking to build up capital for the future. This would suit somebody who is currently earning and who's income matches or exceeds their outgoings. These kinds of objectives have a considerable bearing on the choice of investment strategies and hence asset allocation.

4. Age and investment duration. Age is critical in determining investment horizons. For example, a young investor may have a higher tolerance to risk, since they have sufficient time to recoup short term losses caused by volatility. Conversely, older investors may seek a more cautious approach to investment, since they may wish to preserve capital as they go into retirement. A key factor in the reduction of any risk associated with an investment is the length of time for which it is held. In most cases, the longer the term of the investment the lower the risk. If you are likely to need access to the funds at short notice, you may be better served by a deposit based account as opposed to a collective investment vehicle which is subject to initial charges. As such, we consider an investment in a collective, equity based fund as a medium term investment where your time horizons need to be for five years or more.

5. Affordability is implicit in determining investment decisions. Investors need to carefully consider whether they can afford to take risks. For example, someone with high levels of personal debt would be better off paying these debts off before embarking on investment portfolio construction.

6. Tax implications. You need to take into account the wider impact your investment portfolio will have on your income, capital gains and inheritance tax position. ISA's, for example, cannot be placed in trusts, since they are already contained in a trust and this can impact adversely on inheritance tax planning which often relies on trust work. Equally taking income from your investments can impact on means tested benefits and so the consequences need to be considered diligently. Triggering chargeable events from unit trusts can have adverse consequences if they exceed your capital gains tax allowances. If you have any doubts you should consider seeking advice from an accountant or independant financial adviser.

7. On-going monitoring and supervision. After you have decided on your asset allocation, it is important that you keep the funds under on-going monitoring and supervision. Financial markets are constantly changing, providing new opportunities, or "buying opportunities" and also risks, such as sectors which have become overvalued- indicating that it is appropriate to look to take profits and crystalise gains. Re-assessing and re-balancing a portfolio is critical in ensuring optimal performance. The performance of a fund is often compared to a benchmark index and/ or with sector average performance. Sector averages denote the average performance of all funds within that particular sector. It is important to look for funds and fund managers that consistently out-perform the sector average over a sustained period of time.