plonkee money an english-er's thoughts on personal finance

March 17, 2008

basic guide to Stocks and Shares ISAs part 4: all about allocation

Filed under: investment — Tags: , , , , , — plonkee @ 12:00 pm

the guide to Stocks and Shares ISAsFor a while now, I’ve had a trickle of requests for a basic guide to investing in Stocks and Shares ISAs.

As I want to go through things carefully, I’ve split all the details into several different parts, starting with thinking about yourself and what you want with the money, and moving into what there is available, and the nuts and bolts of products and investments. This is part 4 of the basic guide to Stocks and Shares ISAs.

Previously on the basic guide to Stocks and Shares ISAs:

In general, an asset allocation for the long term should have a portion of equities, a portion of bonds, with maybe a splash of property, a tiny sprinkling of commodities and cash as needed. More cautious investors want more bonds and cash, and more adventurous investors want more equities, property and commodities.

not sure what to do?

Join the club. I’ve always been wary of asset allocation. I sort of understand the basics of the different types of investments, but it’s hard to match that up to what I need to invest in. So, I’ve looked at other types of investment which have guidelines for people that aren’t sure what to do with their investments to get some ideas.

Firstly, stakeholder pensions must have a default investment option and have to offer “lifestyling” so that at least five years before to retirement their pension will gradually be moved into less volatile investments.

Scottish Widows Stakeholder Pension does it like this:

For those who’d prefer not to make the choice of investment fund themselves, we have a default fund called the Consensus Fund, which may be suitable for your investment needs.

The Consensus Fund aims to achieve long-term growth by investing in a balanced portfolio of UK and overseas shares, fixed interest, index-linked stocks and cash deposits. Investment in these assets is made through a range of index tracking funds, or where appropriate through direct investment, again on an index tracking basis (…)

We will automatically switch the funds you have built up approximately 75% into the Pension Protector Fund and 25% into the Cash Fund over the 5 years before your selected retirement date.

Secondly, Stakeholder Child Trust Funds must spread the risk by investing across a range of companies (it must invest in equities) and have to start moving the money to lower risk investments once the child is 13 (they are accessible when the child is 18).

Children’s Mutual Baby Bond Stakeholder CTF does it like this:

[Insight Investment Foundation Growth Fund] is the fund that the Baby Bond invests in.

The fund aims to achieve long-term capital growth by investing in a representative sample of UK equities and for these assets to produce a return that before charges and expenses matches the total return of the FTSE All-Share Index. (…)

Once lifestyling starts, we gradually move money into lower risk assets such as Government bonds and cash.

From reading about a variety of different default long term investment plans, my best guess is to start with an asset allocation relating mostly to my risk tolerance, and then switch it gradually over the last 5 years before I need it to more bonds and cash.

So if I was a cautious investor, I might start with an asset allocation of 50% of my money in equities and 50% in bonds. Then to lifestyle it, I might do the following:

  • six years before required – 50% equities, 50% bonds, 0% cash
  • five years before required – 40% equities, 50% bonds, 10% cash
  • four years before required – 30% equities, 50% bonds, 20% cash
  • three years before required – 20% equities, 40% bonds, 40% cash
  • two years before required – 10% equities, 30% bonds, 60% cash
  • one year before required – 0% equities, 20% bonds, 80% cash
  • when required – 0% equities, 0% bonds, 100% cash

I guess that a cautious investor might be 60% or less in equities, 10% or more in bonds, 20% or less in cash, and 5% or less in property. A medium investor might be 60% to 80% in equities, 10% or more in bonds, 10% or less in cash, and 5% or less in property. An adventurous investor might be 80% or more in equities, 10% or less in bonds, 5% or less in cash, and 10% or less in property.

The following tools Vanguard Investor Questionnaire should give you some ideas for your own ideal asset allocation. Some of the questions are US-specific just mentally substitute UK as they are about your comfort with different types of investments

An ISA really is just a container for investments. Each investment (a fund, or a share purchase) will have a minimum amount. As I mentioned earlier, usually there’s one minimum for a regular monthly investment, and a separate one for a lump sum investment.

ISA investment minimums tend to be in the £20-£100 range for a monthly commitment, and £100-£500 for a lump sum. This means that we’re going to need to tweak our asset allocation to match the minimums. In addition, I mentioned before that cash is best held outside a Stocks and Shares ISA.

Suppose you have £100 to invest each month, and the rough asset allocation plan you’ve worked out is:

  • 60% equities
  • 30% bonds
  • 5% property
  • 5% cash

that would translate in £ terms as:

  • £60 equities
  • £30 bonds
  • £5 property
  • £5 cash

You’re unlikely to find good property funds that will accept a contribution as low as £5 per month. One way of getting round you might like to consider is to putting that money into another investment class and move it round later when your money has grown. Moving money inside an ISA is generally very easy. So you might modify your asset allocation plan to:

  • £65 equities
  • £30 bonds
  • £5 contribution to a regular savings account (outside your Stocks and Shares ISA)

Another alternative is to invest your money in a fund that itself invests in different sorts of assets. So if you’ve got a lump sum of £250 and a rough asset allocation plan of 50% equities and 50% bonds, you might invest the whole lot in a fund which is itself invested 50:50 in equities and bonds.

The lower your amount that you have to play with, the greater the compromise that you need to make at the start. But, don’t forget, this is a long term investment, and we’re hoping to use the power of compound growth to get a lot money. The plan is, that you won’t always have a small amount of money to play with, after a while it will be big enough that you can tweak it to what you really want.

still to come…

Coming up in the basic guide to Stocks and Shares ISAs:

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