Portfolio management

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6. Diversification: asset allocation

"Asset allocation" is investment jargon for two very simple questions:

1. What sorts of things should you buy for your portfolio?
2. How much of each thing should you hold as a percentage of your portfolio?

As always, the answers depend on your investment aims and, above all, on

• whether you are broadly seeking growth or income, or a mixture of the two
• if you are after growth, how much risk you wish to take in pursuit of higher returns.

Your choice of means is equally simple. Broadly, it comes down to a three-way split between:

1. stocks, including most unit or investment trusts, which are portfolios of stocks
2. bonds
3. cash.

The diagram below shows how various differently allocated portfolios, with different aims, performed over the 71 years from 1926 to 1996. Although based on American data, it is worth studying carefully. It will give you a good feel for:

• how to divide up your portfolio depending on your strategy
• the sort of returns you might realistically expect from each strategy in the long run
• the trade-off that always exists between risk and return
• the sometimes severe drops in value you have to put up with in order to make those returns.

Performance of various portfolios over time

Bear in mind these are theoretical portfolios only. In practice, you may always hold some percentage of cash, if only as a result of receiving dividends from your holdings. You would also expect to keep making regular cash contributions throughout your life. These will substantially boost the ultimate value of your portfolio, once you begin to make investment returns on this money too.

1. First things first 2. Should you invest before paying off your mortgage? 3. Do you want growth or income? 4. Diversification: summary 5. Diversification: Safe custody 6. Diversification: asset allocation 7. Diversification: shares 8. Diversification: sectors 9. Diversification: countries 10. Balancing your portfolio 11. What should you hold where? 12. Tips for married couples 13. Lump sum or drip feed? 14. The role of cash 15. Rebalancing your portfolio 16. What to do with dividends 17. All about bonds 18. What to do if you inherit a portfolio 19. Benchmarking performance 20. Setting up a portfolio spreadsheet 21. Conclusion

• One Up on Wall Street