Join our community of smart investors

Six steps for better investment returns

An annual portfolio review can help you achieve your investment goals
January 11, 2018

January to March is a good time to review your investment portfolio if you are thinking about using up annual investment allowances such as individual savings accounts (Isas) and pensions before the end of the tax year in April. But to invest new money effectively, you first need to review your overall goal, risk appetite and existing investments. You can do this by following these six key steps.

1. Remember your goals

We all have different reasons for investing. You might be focused on growing a retirement pot, or perhaps you are already retired and drawing an income from your investments. Or maybe you are investing to cover your children's education costs or a property purchase. Whatever the reason, you need to be clear about why you are investing and the timeframe over which you plan to invest, as this will determine your strategy.

Adrian Lowcock, investment director at Architas, says: "Reminding yourself of why you're investing helps you to focus on longer-term rather than short-term issues, as most people will be aiming to invest for five years or more. This means you can ignore a lot of the noise that goes around markets."

Sometimes a change in personal circumstances such as losing your job, going through a divorce or getting a promotion may mean that you need to revisit your investment goals. Taking time to review your portfolio at least once a year – regardless of what month it is – will keep you focused on meeting your goals and making changes if necessary.

 

2. Assess whether your investments are meeting your objectives

Assuming you are happy with what you are trying to achieve, the next thing to consider is how effectively your portfolio is working for you. One way to do this is to compare your portfolio against private investor benchmarks, which financial advisers often use to measure the performance of their client portfolios. These include the FTSE Private Investor Index Series, on which you can get performance figures from data providers such as FE Trustnet. These indices can be used as performance benchmarks for UK domestic investors with a growth-orientated, income, balanced or conservative risk objective. The indices incorporate returns from FTSE indices including UK equities, foreign equities, fixed income, cash and investment trusts, according to variable percentage weightings set by committee based on average allocations across private client investment managers.

Comparing how your portfolio has fared against a private investor benchmark or even against your own personally defined targets will help you understand what, if anything, you need to change to better meet your investment goals.

 

3. Reassess your risk appetite

Figuring out your risk appetite is a key part of defining your overall investment strategy. And when it comes to reviewing your portfolio you should make sure your investments continue to match your risk tolerance.

The amount of risk you are comfortable with will be linked to how long you are planning to invest. If you are investing for the next 10 or 20 years your portfolio has more opportunities to recover from periods of poor market performance and you can therefore take on much more risk. But if you are planning to realise your investments within the next three to five years your portfolio will have much less time to bounce back from market falls, so you should take less risk.

"With market valuations looking high across many asset classes, you could argue it's impossible to escape risk right now," says Martin Bamford, chartered financial planner and managing director of Informed Choice. "But investors still need to gauge how comfortable with risk they are. If markets corrected by 20 per cent would you be able to deal with that and would your circumstances allow you to cope with it?"

Mr Bamford also suggests only taking the level of risk that is relevant to achieving your goals. He often sees clients with a high-risk appetite who want to construct a high-risk portfolio, but their investment goals can be achieved with less risk. 

 

4. Consider asset allocation and geographic spread

Another way to make sure your portfolio's risk profile doesn't stray away from what you intend is by keeping tabs on your asset allocation.  

Jason Hollands, managing director at Tilney Group, explains: "Existing portfolios drift over time as different investments do not all move in tandem with each other, which can lead to a situation where the risk profile of a portfolio mutates into something very different from what may have originally been intended."

Darius McDermott, managing director at Chelsea Financial Services, adds: "A lot of investors who invested in emerging markets in the early 2000s might have started out with a 5 per cent allocation to that area, but because emerging markets did so well during that period they would have ended up with 10 or 20 per cent just by letting the performance ride."

If your portfolio's asset allocation has gone out of sync it is important to rebalance it. You should also ensure it is sufficiently diversified by having a mix of assets like bonds, equities, commodities and property, as well as exposure to different geographic regions.

"Market corrections such as we saw in 2007-08 are rare, but market corrections of 10 per cent are quite common, so investors need to accept that there will be several of these over their investment lifetime and factor it in," says Mr Lowcock. "Being diversified will protect against the worst of it. For example, in 2016 the Brexit vote meant the UK was hit, but if you were globally diversified your portfolio still went up."

He says that while it makes sense to have up to half of your geographic exposure to the UK – the home market – you may also want to allocate to other developed and emerging markets. For instance, a balanced portfolio might have 15 per cent exposure to the US, 10 per cent to Europe, 10 per cent to Japan, and between 5 and 10 per cent to Asia and emerging markets, depending on risk appetite, with the remainder in the UK.

But don't go over the top. Many advisers suggest holding at most 20 funds, because if you have more you risk duplicating holdings and diluting overall performance. And the more investments you have, the harder it becomes to keep abreast of your holdings.

 

5. Review each fund's performance

When you are clear about your goals, risk appetite and asset allocation, you need to evaluate individual fund holdings and decide whether to sell, maintain or increase your holdings in them.

The first thing to assess with an active fund is how it has performed against its peer group. Colin Low, managing director of Kingsfleet Wealth, explains: "You want to hold a selection of investments that are going to do better than average, because if they do worse than average then you're better off with a passive fund. The way to determine if a fund is better than average is to see if it is consistently outperforming its peers."

He suggests evaluating a fund's performance against its sector peers across individual 12-month periods rather than cumulative one, three and five-year periods. This is because a particularly strong or weak one-year return can skew the performance figures over three and five years.

Checking how a fund performed compared with its sector average each year will help to show whether it is a consistent outperformer or not. And if a fund has consistently underperformed its sector average during the past five years, that is a good case for ditching it.

You should then compare a fund's performance to its benchmark to see if it has successfully beaten it. Even good funds can have a poor year every so often, but if a fund has consistently underperformed its benchmark for the past three consecutive years you should think twice about it. 

"If funds are underperforming you shouldn't immediately remove them from your portfolio as it could be down to their style," says Mr McDermott. "For example, over the past few years the value style has been out of favour which means many value funds look like the poor relative over a three-year period."

But if a fund is underperforming in conditions where you would normally expect it to perform well, for example a value fund that's lagging the market despite the value style being in favour, that would be a legitimate reason to sell it.

Try to be ruthless and sell funds that are consistently underperforming as they will act as a drag on your portfolio's returns.

"Something we notice with potential new clients is how personal their investments can be," says Jeremy Greenwood, senior relationship manager at Seven Investment Management. "Clients may have had a previous good experience with a certain stock or sector, and this can lead to a behaviour bias in their investment decisions. We see clients holding on to losers in the hope they recover some of their former sheen or having an overweight position in a sector familiar to them, exposing their wealth to unnecessary risks."

Other reasons to sell a fund might be if it has changed its investment strategy, its manager is taking more risk than you are comfortable with or the manager leaves. You may also want to consider selling a fund if it has grown too large to be managed in the same way.

"There have been plenty of cases of funds becoming victims of their own success as investors pile in because of good performance," says Mr Hollands. "Different funds will have different issues with capacity. A government bond fund should be able to cope with getting larger as it has a very liquid market, but a fund that historically invested in small and medium-sized companies would find it difficult as it will no longer be able to access them in the same way."

 

6. Buy only what fits with your portfolio

It makes sense to use as much of your annual Isa and pension allowances as possible by allocating new money to your investments. But only buy a fund if it fits with your objectives, and think carefully about how it will affect your portfolio's risk, diversification and liquidity. 

"People tend to have a habit of thinking they always need to invest in new funds, but setting a maximum limit of 20 funds is good discipline as it makes you reflect on which of your existing holdings a new fund could replace," says Mr Hollands. "One of the biggest mistakes investors make is getting caught up in the end-of-tax-year frenzy and choosing investments on an ad hoc basis. It is so easy to get distracted by whatever funds are flavour of the month without first considering how these might fit alongside an existing portfolio."

Topping up existing holdings is also a valid way to invest new money, particularly if you invest set amounts every month. This is because market fluctuations will allow you to benefit from pound cost averaging. When markets go up and are more expensive, your set amount of money will buy fewer fund units, and when markets fall and are cheaper, your money will buy more units.

 

Thinking of reviewing the cost of your investments? Check out our Broker Comparison tool.