How to best mix your investment options
As an investor, the greatest concern is growing your investment to deliver higher risk-adjusted returns. Risk-adjusted return hones an investment’s return by measuring how much risk is involved in producing that return, the risks could be as a result of prevailing economic environment brought about by the cyclical nature of investments markets due to varying macroeconomic factors like politics, inflation and country growth. It is therefore important to know how to determine an asset allocation that best suits your personal investment goals and needs. Your portfolio should thus be constructed in a way that guarantees you can meet your future financial needs while delivering the best returns. In today’s financial marketplace, there are various investment options which range from Fixed Income, Equities, Real Estate, Structured Products to others such as Derivatives and Private Equity investments.
So, out of all the available investment options, how do you determine the best mix to deliver higher-risk adjusted returns for your portfolio? This involves conducting an analysis of your investment objectives and constraints in order to inform the investment strategy. Discussed below are 8 key factors to take into consideration in determining the best mix for your investment options:
This is the probability that an investment may not earn its expected rate of return. For investors, it is of paramount importance to figure out your risk tolerance level i.e. your capacity to take on risk, and not just your willingness to bear risk. Generally, the approach is usually to conform to the lower of the investor’s ability or willingness to take on risk. To gauge your risk profile, it would be highly encouraged that you take a risk profiling test from your investment advisor to avoid subjectivity,
This is the expected earnings from an investment; they include dividend, interest, rent, capital appreciation etc. Getting returns is the core reason for investing. Generally, the higher the risk an investor takes on, the higher the expected return, and the lower the risk, the lower the expected return,
This refers to how quickly an asset can be converted into cash without a significant loss in value. An investor who requires regular cash flow to fund possible expenditure needs may require liquid assets to be held in their portfolio,
This refers to the amount of uncertainty or risk about the size of changes in a security’s value. A higher volatility means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time. Other than risk, the return on an investment is also influenced by its level of volatility,
This refers to the period that an investor intends to hold an investment, and it is dependent on the investors’ income needs and risk profile. In general, the longer an investor’s time horizon, the more risk and less liquidity (especially in case of alternative investments such as Real Estate and Private Equity) the investor can accept in the portfolio,
Sophistication of the Investor
This refers to how knowledgeable an investor is in terms of investment products and their capacity to invest. Usually, investment products are classified into retail investment products and institutional investment products, with some investment products being suitable for all classes of investors, while others are tailor-made to target a specific class of investors. The more knowledgeable you are about an investment product the better the chance of you making the right decision in respect to your portfolio,
The tax treatment of various types of investments is also a consideration in portfolio construction. Some investment accounts like pension accounts may be tax exempt, hence investors with such accounts can choose fully taxable securities to hold in their portfolios. For accounts that are fully taxable, investors may opt for investment securities that are taxed at lower rates, e.g. investing in equities for capital gains that are usually tax exempt or taxed at lower rates,
Each investor may have specific preferences or restrictions on which securities and assets that they can invest. These can range from ethical preferences, religious preferences or restrictions placed on investing in rival companies.
After analyzing an investor’s investment constraints, the next step is to construct the investment portfolio, taking into account the importance of diversification to minimize risk in the portfolio. The investment portfolio can be constituted of a variety of asset classes which include:
- Fixed Income: These are securities that promise to pay a given return to an investor, in the form of coupon payments and repayment of principal on maturity. They include Treasury bonds and bills, corporate bonds and fixed deposits in financial intuitions. Key characteristics that make it appealing to investors under various macroeconomic conditions include:
- They cover short to medium term investment horizons, and exhibit low volatility and hence suited to investors who desire stable returns and are risk-averse.
- They are highly prone to changes in interest rates. Thus, when interest rates are rising, more investors are attracted to the fixed income market owing to higher yields.