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Blend your assets to protect your finances

• 6 min reading time

When your investment portfolio contains a range of different assets, you reduce the impact that a potential stock market fall could have on its performance. Here's why.

It's a cliché, but when it comes to investing, the phrase “don't put all your eggs in one basket” is a mantra to live by.

That's because a portfolio that contains only one type of asset – say, a few shares – will be exposed to any falls in the market. In extreme circumstances, such as a financial crash, the value of your portfolio could reduce greatly.

Alternatively, a portfolio which contains too much cash has very little potential for growth, meaning you might not reach your financial goals as soon as you hoped.

So, it's vital to blend different types of assets together (for more information on asset types, visit our field guide). This will create a diversified portfolio that meets the level of investment risk you want.

The exact make-up of your portfolio will also depend on your financial goals, the amount of money you want to invest and length of time you're investing for.

How different assets perform

The main types of investments, or assets, are equities (another name for shares), bonds and cash. Mixing these assets together – known as diversification – is important because each comes with its own level of risk.

Their performance is also affected by the different market cycles. Some assets perform better than others when the stock market is rising, for instance, while others perform better when it is falling. Here is a quick overview of the main asset types and their 'risk versus performance' profiles:

• Shares: these are generally considered to be the highest-risk asset class. They also tend to perform more strongly than other types of asset when the stock market is rising.
• Bonds: these are a type of interest-paying loan issued by governments or large organisations, and when it comes to levels of risk have traditionally fallen somewhere between shares and cash. Since the early 2000s, the trend has been that when equities fall in value bonds generally rise in value. However, it can't be assumed that this behaviour will continue into the future as bonds' performance also depends on wider economic trends, such as interest rates.
• Cash: is regarded as the lowest-risk type of asset because there is little chance of it suddenly dropping in value. However, if interest rates on cash accounts are lower than the rate of inflation, as is the case in the UK at time of writing in September 2018, cash savings lose value over time. This means that, while a portfolio comprised solely of cash is low risk, it may offer minimal, or zero, growth.

Blending assets is regarded as one of the best ways to protect your portfolio from a stock market crash. If it has a 100% focus on shares, it's far more exposed to downturns than a portfolio made up of, say, 60% equities, 30% bonds and 10% cash.

How to choose assets

Asset allocation refers to the proportion of your portfolio that you put into each type of asset. This decision is personal, because it depends on the level of risk you want to take and your ability to cope with any losses.

This personal approach to risk can be influenced by several factors, including the following:

• Your age
• How much money you have
• Your financial goals
• How long you're investing
• Your health

Someone who is aged 30 and is investing for their retirement can generally afford to take on more risk than a 25-year-old who wants to buy a house in three years' time. This is because the 30-year-old can put away their money for a long period, possibly up to 40 years, which gives them the potential to recover from any stock market downturns.

If you have shorter-term goals – like the 25-year-old who wants to buy a house in three years' time – there is a real chance the stock market could fall just when you need to cash in your investments. That would mean, if your portfolio contains a lot of equities, that its value could be reduced at just the wrong moment.

In general, people who are investing for longer-term financial goals tend to choose equities so there is greater potential for their money to grow. For those seeking results in the shorter-term, it is usual to reduce the number of equities and increase the focus on bonds, or even cash.

Investing in equities in retirement

It used to be assumed that people would gradually reduce their portfolio's reliance on equities as they approached retirement. This is because most people used their pension to buy an annuity – a type of insurance product that pays a guaranteed income for life. Retirees didn't want their portfolio to drop in value just before they made their annuity purchase.

Today, however, many retirees opt for a pension income drawdown instead. Pension money stays invested and the income you receive depends on how your investments perform. As a result of low interest rates and longer life expectancies, most retirees now want to make sure their investments keep growing – and that means keeping some equities alongside bonds and cash.

Creating an investment portfolio isn't a one-off exercise. As your life circumstances change, you need to review and adjust your portfolio so it continues to meet your individual needs. You can find out more about this in our Managing Your Portfolio guide.