Let’s assume you fall into one of two categories. In the first you work and have plenty of spare income after paying your mortgage, bills and making pension contributions. In the second you are retired, own your home and have a secure pension income. This is important because in discussing asset allocation for a 2019-20 Isa, we need to caveat that you should have the capacity to take some risk.
You should always have a cash reserve for emergencies. You may not feel that, given the need to be prudent and maintain such a buffer, you can invest all your Isa allowance this year. Even if this is the case, you should still park the cash in your Isa as you will have good access to it. And if you don’t need to dip into this reserve, you will have taken up a valuable tax-free allowance. After all, you can invest £20,000 each tax year, so you can build up a sizeable tax-free war chest for when you have greater capacity to invest in the future.
Following the tumultuous end to 2018, January saw markets recover, but there is still plenty of uncertainty for risk assets and some investors may choose to keep part of their Isa cash on the sidelines anyway. Working on the principle of building up a position in risk assets rather than market timing however, we’ll assume most of the Isa allocation will be invested.
Benchmarks and asset weightings
Whether you choose to invest in funds, or both these and individual shares, you should consider an appropriate benchmark for your portfolio. The starting point should be how much risk you wish to take. A good way to think about this is in terms of risk relative to holding a portfolio entirely made up of shares. Investors for whom an Isa allowance represents only a portion of their overall wealth won’t feel the need to diversify within the tax vehicle and could choose to go for 100 per cent equity risk.
What we mean by risk in portfolio management is the size of peak-to-trough falls in the value during bad periods and the length of time it takes to recover from these. The Private Client Indices compiled by Asset Risk Consultants (ARC) help categorise portfolios by the level of peak-to-trough falls asset mixes would have relative to global equities (shares). For example, its steady growth portfolio suggests a benchmark mix of assets that has roughly 60-80 per cent of the peak-to-trough risk of global shares.
Services like ARC’s online Suggestus tool can tell you where your portfolio choices sit in the spectrum of risk-taking and which benchmark is appropriate. You can then measure how your investment decisions perform against a peer group and the benchmark weighting which includes shares, fixed income (mostly bonds), alternative investments and cash. You may not choose to have exposure to all the asset classes in the benchmark portfolio but it is useful to have a diversified benchmark. The benchmark returns act as a yardstick for how much reward your choices are earning for taking the same amount of risk.
Get comfortable
Focusing on the potential size of peak-to-trough falls is a good way of getting comfortable with your portfolio choices and sticking with them. This means that you’ll be much more likely to sidestep the emotional pitfalls of investing because you’ve already made a realistic assessment of what a temporary setback could look like. Many investors’ natural loss aversion leads them to make mistakes such as selling out of winning positions too soon and running losers in the hope they will recover. Knowing when to sell is probably the hardest part of investing, but setting expectations of risk can at least guard against the danger of doing this because you’re getting jumpy in a downturn.
Much attention at the start of the year was given to China, with recorded gross domestic product (GDP) growth at its lowest level since 1990 and huge levels of debt in the economy. The January rebound has been partly accredited to rising hopes of a breakthrough in trade negotiations between China and the US, but this is far from certain.
Aside from the potential negative impact of trade disputes, the main issue for the US economy was the fear that the US Federal Reserve was hiking interest rates too quickly, potentially choking off growth and creating a roll-over financing headache for the heavily indebted corporate sector. Nerves have been assuaged somewhat by Federal Reserve chair Jerome Powell’s softening rhetoric. But whatever the action on monetary policy, there are also worries that the economy is ready for a cyclical down-swing, reinforced by notable earnings misses from companies including Apple and Amazon.
Closer to home the UK is facing massive uncertainty as its exit from the European Union (EU) threatens to descend into farce. And on the other side of the Channel, civil unrest, youth unemployment, economic stagnation and the Italian banking system have proved that the EU’s problems don’t start and finish with Brexit. All in all, there are plenty of reasons investors can expect asset markets to be volatile in 2019.
IC Isa guide 2019
