At WESFIN we believe that portfolio construction should follow three steps:
- Establish the risk profile of the investor. The investor's risk profile is influenced by a number of factors that are not at all subjective.
- Decide on an appropriate asset allocation split for the investor. The investor's risk profile determines the asset allocation of the portfolio. The split between asset classes significantly influences the risk of the investment.
- Select suitable funds within each asset class.
Asset allocation serves to diversify risk through the selection of uncorrelated assets. Studies show that asset allocation is the single most important decision influencing investment returns over the long-term. Asset allocation should be reviewed annually. If required must then be rebalanced to remain within asset allocation guidelines. The asset allocation within the foreign component of the portfolio should be diversified across the same asset class bands as used for the local allocation.
Definition of investor risk profiles :
A conservative investor requires stable investment growth or a high level of income. The primary investment goal is capital protection. This investor may require access to the investment within three years.
A cautious investor requires stable growth in his/her investment and is uncomfortable when investment values decline. The investor may require a moderate level or income and is likely to have an investment horizon of three to five years. The primary investment goal is capital protection.
A moderate investor invests for the longer term (five to seven years) and requires no income. The investor can tolerate fluctuations in the value of his or her investment from time to time. The primary goal is capital growth.
An assertive investor invests for the long term (at least seven years) and requires no income. Typically, this investor is prepared to accept more risk than a moderate investor, but does not want full exposure to equities. The primary investment goal is capital growth.
An aggressive investor invests for the long term (at least ten years) and seeks the highest possible growth. Typically, the investor is prepared to accept substantial fluctuation in the value of his or her investment. The goal is long-term capital growth.