The 7 Secrets of Money: The Insider's Guide to Personal Investment Success by Brown Simon & Sherwood Ben & Stott Richard & Wilson Bruce

Author:Brown, Simon & Sherwood, Ben & Stott, Richard & Wilson, Bruce [Brown, Simon]
Language: eng
Format: epub
Published: 2011-10-13T16:00:00+00:00

FTSE data courtsey of FTSE. MSCI data copyright MSCI 2010, all rights reserved

While this technique relies on historical performance that may not be repeated in the future, and does not consider various investment costs, it may help you think about the risk–return trade-off and visualise the range of potential outcomes based on the aggressiveness of your strategy.

A good adviser will help you find the right balance and the right portfolio to reflect your approach to risk and return.

5.5 Refining your equity allocation

After establishing the basic equity–bond mix, investors should turn their attention to the equity allocation, which is where the best opportunities to refine the risk–return trade-off are found. Investors who are comfortable with a higher level of equity risk can overweight or ‘tilt’ their allocation towards riskier asset classes that have a history of offering average returns above the market.

We have talked about the research published by Eugene Fama and Ken French. 9 This found that shares of smaller companies (small cap) have had higher average returns than those of large companies (large cap), and that so-called shares in ‘value’ companies provide investors with higher average returns than shares in ‘growth’ companies.

To recap: we define value companies as those companies whose share price is low compared to the value of the company’s assets. Conversely, growth companies are those whose share price is high compared to their assets.

By holding a larger portion of small-cap and value equities than mainstream indices or a typical portfolio, an investor increases the potential to earn higher returns for the additional risk taken.

The following graph shows the outperformance of small-cap and value shares compared with the FTSE All Share Index, which measures the performance of main market shares in the UK.

Figure 8 Returns on different asset classes in the UK, 1956–2009 10

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