INVESTING money should be a simple game, but a frequent lack of common sense makes it more complicated than it needs to be.
The performance of an investment portfolio is determined by a combination of the mix of asset classes, the choice of investments within an asset class and timing. But while academics continue to debate the topic, most studies show that differences in
investment returns are almost entirely driven by asset allocation and when, in terms of timing, these asset allocation decisions are taken.
Of the three factors above, the choice of investments within an asset class has the least impact on the overall performance of an investment portfolio. Yet, this is the area on which too many investors focus too much, looking for that elusive star fund manager who will out-perform the rest of the pack.
Despite this focus on finding the top-performing funds, the reality is that the worst-performing fund in the right asset class is likely to outperform the best performing fund in the wrong asset class.
Over the past year (at the time of writing) the best-performing UK Equity Income fund made a loss of 23 per cent. In contrast, the worst-performing index-linked gilt fund made a positive return of 4.9 per cent. It is interesting to consider whether investors in either of these funds would be happy with this performance.
Having established that investing in the right asset classes is more important than investing in the right funds, is there any way that investors can ensure they benefit by having larger weightings in the best performing asset classes?
Many financial "experts" try to predict which asset classes will perform well and badly. Some will use a vast array of economic data to come to their conclusions, while others use little more than guesswork.
But what are the chances that you increased your equity weightings in the 1990s and then came out of shares just before the market crash at the beginning of the millennium? The former may be possible, but the latter is highly unlikely.
Contrast this with the sentiment in March 2003 as stock markets bottomed. Very few investors increased their equity weightings at that time. The biggest selling funds in March 2003 were fixed interest, following a period of strong performance and just as equities were about to rebound.
Some of the best periods often follow sharp falls when most people are put off further investment.
In this example, from the bottom of the equity market in March 2003, over the next nine days there was a rise of 18 per cent, this being about 40 per cent of the total rise into the summer of 2004.
• Graeme Lind is a wealth adviser at Towry Law in Edinburgh
