Several factors will determine the shape of your portfolio. The first of these is your investment objective. This takes into account whether you’re investing for income or for growth. If you want to generate income, perhaps to supplement your pension or your salary, then you need to consider income-producing investments such as fixed interest or equity income funds. However, if it's growth you're after, then your portfolio can be more biased towards equities
Or, you could achieve growth by opting for an equity income fund and reinvesting the income.
Your attitude to risk is also important. “Ask yourself how you would feel if you lost 30% of your investment,” advises James Davies, investment research manager at Chartwell. “This should give you an indication of how comfortable you are with taking risk, as well as the areas you should be investing in.”
There are some general rules to help you assess the risk profile of a particular fund or share. “Size is important,” says Davies. “Larger companies are generally less risky than smaller ones.
Additionally, location plays a part – the UK is the least risky market to invest in as you don’t have a currency risk. It is followed by other developed markets such as Europe and the US, and then risk increases as you go to Asia Pacific and emerging markets.”
Specialising, whether in an individual country, commodity or sector, will also increase the risk. This is because of the concentration in one area. “You can see gains of 50% to 60% in a year on a commodity fund, but you can also see double-digit losses,” explains Davies.
Your timeframe will also play a part in determining what your portfolio looks like. As a rule of thumb, the longer you have to invest, the more risk you can afford to take.
For example, if you’re starting an investment plan for your newborn baby’s 18th birthday, you could plump for riskier investments, such as emerging markets, specialist funds and smaller companies. However, if you wanted to cover their school fees in five years’ time, you should opt for something less volatile – to ensure its value does not halve the day before term starts.
Also, think about your other investments when you build your ISA portfolio. This will ensure you don’t have too much exposure to a particular asset – if it drops in value, you’ll be affected whether or not it was within your ISA. As an example, if you have plenty of savings built up already, you might decide to put the full £7,200 into equities rather than split your allowance between cash and stocks and shares.
Once you’ve decided on the level of risk you’re prepared to take and where you should be investing to realise your objectives, you need to think about what will make up your portfolio. Diversification is important here as this will help to reduce the risk. Although it’s possible to buy a fund that holds a couple of hundred different shares, it’s worth buying funds from different management groups so you benefit from different investment styles.
Generally speaking, you should try to have less than 25 funds in your portfolio as spreading yourself too thinly could return your returns. Another strategy you may want to consider is regular savings. “It’s impossible to time the market, but if you drip-feed your money in on a regular basis you’ll reduce the possibility of going into the market at the top,” explains Davies. “And, when prices are low, you’ll benefit from being able to buy more units.”
As well as allocating your annual allowance, either in one lump sum or through regular savings, you might also want to take advantage of the change in the rules that came in April 2008. These allow you to transfer existing cash ISAs into stocks and shares and could give you some extra funds to start building your portfolio.
While it’s possible to manage your portfolio yourself, possibly the easiest way to do this is with a fund supermarket such as Funds Network or Interactive Investor’s ISA supermarket.
Not only do funds supermarkets allow you to pick from a wide range of different funds and managers, but they also include tools to help you build a diversified portfolio that suits your needs. These include risk profiling tools to help you determine your attitude to risk and find the right funds to invest in. They’ll also let you test your portfolio to make sure it remains correctly balanced.
Although a fund supermarket does take a lot of the hassle out of building your portfolio, if you’d like personalised advice, speak to an IFA. They will be able to assess your requirements and recommend suitable funds. Whether you decide to go down the do-it-yourself route or to use an adviser, make sure you regularly review your portfolio. Although it might be perfect when you put it together, stockmarket performance – as well as changes in your risk profile and investment objectives – can mean it gets out of shape over time.
“Review your portfolio regularly,” recommends Davies. “You need to assess it at least once a year to be sure it’s still appropriate. You might not need to do anything as you can correct it with the next year’s ISA allowance, but do make sure your money is working as hard as possible for you.”
James Davies, investment research manager at Chartwell:
* Allianz Pimco Gilt Yield
This is a conservative fund that is 100% invested in gilts and managed by Pimco, which is one of the largest bond managers in the world. It’s only yielding 3.5% at the moment, but it did return 13.1% in the year to the end of January 2009.
* Neptune UK Equity
A good core UK equity fund that gives broad exposure to the UK stockmarket. Although it is a UK fund, it has a global view in terms of identifying the driving forces behind the economy. This means it has been out of financials for some time, but is investing in UK companies that benefit from emerging Asia.
* Ignis Cartesian UK Opportunities
Slightly higher risk than Neptune UK Equity, this fund invests across the UK stockmarket but with a bias towards small to mid-cap companies. These companies are more nimble and under-researched so they would suit a bolder investor.
* First State Asia Pacific Leaders
An aggressive overseas fund that has performed well over the last few years. Although it lost 16.2% over the course of 2008, it did gain more than 40% in the previous year. The manager, Angus Tulloch, understands the market and benefits from First State’s presence in the region.
Sheridan Admans, investment adviser at The Share Centre
* BlackRock UK Absolute Alpha
This fund attempts to produce positive returns and to beat the return on cash by using derivatives and other trading strategies. This means it should be uncorrelated to the equity market. It’s a complex fund, but the volatility is low. However, I wouldn’t recommend that it makes up more than 10% of your portfolio.
* M&G Corporate Bond
A low-risk fund that aims to produce a better return than you could achieve from gilts by investing in corporate bonds and other securities. It’s AA-rated, and although the fund has suffered in the downturn, it hasn’t suffered as much as other funds.
* First State Global Listed Infrastructure
This fund invests in companies that are infrastructure-facing, such as water companies, airports and gas pipelines. These are defensive areas of the market which can fund themselves better in the current economic climate and will benefit from government stimulus packages. The fund has a yield of 4.5% and would suit your portfolio if you want global exposure.