Keeping it simple is usually a good principle in investing – and that’s definitely true when it comes to deciding what should make up the core of your portfolio. There are only a handful of established, transparent and proven asset classes that have distinctive properties. Striking the right balance between them is the first decision in any investment strategy.
Investing for growth
Equities have historically been the best choice for growing your wealth: shares have outperformed bonds and cash in all major markets over the long run. If you’re young and saving for a distant retirement, you might have almost all your portfolio in the stockmarket. But shares are volatile, so an older investor who wants their wealth to be more stable might choose to keep just half (or even less) of their assets in shares.
Your property should mean far more than your house: it could include offices, shopping centres, factories or warehouses. History suggests commercial property returns will be lower than equities, but this asset brings steady income and useful diversification (it may do better during periods of high inflation, for instance). Most of us will invest in property through Reits (see below), which might make up 10%-20% of a balanced portfolio.
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Defending your wealth
Bonds have two main roles: as a steady source of income and as a safer asset that does well when shares swoon. With yields as low as they are, the former now looks less compelling: investors may prefer to stick with equities for much of their income instead of switching entirely into bonds at retirement. But holding safe government bonds helps balance the volatility of stocks, so they could still make up around a quarter of a balanced portfolio even at today’s meagre yields.
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Cash provides a buffer for unexpected expenses, but also means that you are well placed to take advantage of any buying opportunities the market throws up. But too much cash will be a major drag on your returns. An allocation of 5%-10% is sensible in most circumstances (on top of any cash that you expect to need soon – for example, a deposit to buy a house).
Finally, there’s gold. Some investors suggest holding commodities in general, but the yellow metal is the only one with a strong case for being a core holding. Gold pays no dividends or interest; in fact, it usually costs you a small amount in storage or management fees to own it. But it’s a highly liquid and trusted asset that consistently does well during crises. Keeping 5%-10% of your money in gold is a simple way of insuring against a major meltdown.
I wish I knew what Reits were, but I’m too embarrassed to ask
A real estate investment trust (Reit) is a company that owns and leases out property. The exact rules governing how Reits work vary in different countries, but they must usually pay out most of their property income to shareholders each year (a minimum of 90% is typical). They may be allowed to develop properties as well as owning and leasing them, but rent must make up the majority of their income. They may also be subject to other restrictions, such as caps on leverage (the amount they can borrow against their assets).
The compensation for these restrictions is that Reits pay no corporation tax on eligible income and capital gains – unlike traditional property companies, which must pay corporation tax. Instead, shareholders will pay income tax at the relevant rate on the income distributed to them each year. This makes Reits more tax efficient than most other property investment vehicles, because it avoids income being taxed twice.
Reits typically focus on one or two sectors, such as offices, shopping malls or warehouses, rather than covering the entire property market. The range of available Reits also includes specialists in relatively niche sectors such as self-storage units or data-centre facilities. Investors can easily build a diversified portfolio of commercial property by selecting Reits from different sectors and different countries, or by buying an exchange traded fund (ETF) that tracks a broad index of property companies.
The share price of Reits can be volatile (in common with most property-related stocks), especially during periods of crisis when they may be more volatile than the wider stockmarket. However, Reits are much more liquid than direct investment in property or even open-ended property funds (which may struggle to sell assets quickly and can be forced to suspend redemptions if lots of investors want to exit at the same time).
