The reasons underlying this principle are straightforward - if you were to put all your money into one industry, sector or geographical region, you’re giving a hostage to fortune. If they do badly for any reason, so will the value of your whole portfolio.
But, if you’ve put together a carefully chosen and balanced range of investments, then not only will your exposure to one type of asset be limited, but often falls in the value of one will be compensated by rises in another, as other investors shun the poorly performing and drive up demand for alternatives.
A well-diversified portfolio is made up of different types of investments, called asset classes, which carry different levels of risk. The main asset classes are shares, bonds, cash, property and commodities. Each asset class tends to perform differently under similar market conditions, so splitting your assets among categories helps to balance your portfolio. Investors typically choose a percentage they want to invest in each asset class based on their risk tolerance, years until retirement and other factors.
In the UK, property has performed particularly well over recent decades and has proved to be a valuable element in many investors’ portfolios.
How do you start building an IFISA investment portfolio?
While you’re free to invest via multiple peer-to-peer (P2P) lending platforms, you can only contribute to one IFISA account in any tax year. That said, this still enables investors to build up a very diverse portfolio of IFISAs over time.
Traditionally, the diversified investment fund approach has been to go for a combination of asset classes, such as bonds and equities, to maximise the potential for a smooth return over the medium to long-term. The introduction of IFISAs in 2016 however presented a new form of investment, whereby investors can now choose between a wide variety of types of provider.
The main asset classes you can invest into via and IFISA are;
- Green energy
- SME lending
- Consumer lending
The main way to diversify your investment portfolio is to introduce new asset classes that are not correlated to the current investments you may hold. For example, if we consider ISAs, you may have have a Cash ISA and a Stocks and Shares ISA. Given the current low interest rates and the volitility of the stock market you may choose to invest some of your annual ISA allowance into an IFISA. IFISAs may offer the potential for higher returns than a Cash ISA and more stable return than a Stocks and Shares ISA.
You can subscribe up to £20,000 into an ISA in the 2019/20 tax year without incurring any tax liability on the income or on capital gains.
The government introduced the IFISA as a way of extending these ISA tax advantages to the growing P2P lending market, allowing investors to use some - or all - of their annual ISA allowance to lend funds through the P2P lending market and investing in debt-based securities, including property bonds.
What is the most popular type of investment?
According to the Wealth and Assets survey by the Office for National Statistics (ONS), about half (49%) of non-retired UK adults chose property as the best investment, making it consistently the most popular investment option since 2010. The proportion of people who still put property as the top investment has grown by 9%, from 40% back in 2010-2012.
A property bond in an IFISA, which can be held by experienced investors in addition to other ISAs, is a useful, tax efficient way of achieving portfolio diversification in terms of: balance of risks and rewards; a mix of equity and bonds; fixed income as against variable income; and participation in the property market.
Read our blog on how to choose the best IFISA provider.
Are IFISAs the best choice for diversification?
Property remains the second most important asset class after cash and, as such, it will always have an important role to play in any well balanced investment portfolio.
However, that still begs the question: how do you best get into property with investments?
A glib answer, of course, is to buy land and build a house. But that calls for a lot of capital and specialist skills. Likewise, buying a property, improving it and selling it for a profit isn’t easy, again needing capital and skills, as well as a shrewd eye for a bargain and a thorough knowledge of the local market.
Investors still have the option of diversifying their investment portfolio by investing in shares in a publicly listed builders or by investing in a property fund.
Most of the UK’s largest property companies – such as British Land and Land Securities - have converted to REITs, property investment companies whose shares can be bought and sold on the stock exchange.
Shares, however, carry greater potential risk than some other forms of investment. In 2016, several property funds were forced to halt withdrawals following the EU referendum, as investors rushed to take money out. Property funds run by Standard Life, Columbia Threadneedle, Janus Henderson, M&G, Aviva and more suspended withdrawals.
An alternative to shares are property bonds held in IFISAs. Property bonds are a form of IOU where the investor lends their money to the issuer, who commits to repay the amount loaned – the face value of the bond – after a set number of years. The bonds also pay interest at regular set intervals and a fixed rate.
A bond held in an IFISA will generally not offer as high a rate of return as stocks and shares, but it does have other advantages.
First, the fact that it pays a stated income at fixed times gives a portfolio a valuable element of certainty. The investor can plan knowing there is a high chance of these returns. A diversified portfolio containing a number of bonds paying at different intervals can provide a fairly constant income stream and, if the bonds have different maturity dates, the investor can have a rolling series of redemptions which helps liquidity.
Second, property bonds held in IFISAs typically offer a lower rate of return than equities because they carry less risk. Their face value doesn’t fluctuate depending on the fortunes of the company issuing them or depending on the overall state of the markets. This is why they’re so valuable in balancing the more volatile equities in a diversified portfolio.
So, achieving a portfolio made up of a range of asset classes and covering a variety of industries, sectors and geographical locations is undoubtedly important, and you can use an IFISA to do this effectively. With IFISA types including property, green energy, SME lending and consumer lending to choose from, IFISAs are a great way of achieving a spread of investments and a well balanced portfolio. However it is important to remember that returns are not guaranteed and your capital could be at risk.
The CARLTON Bonds product is available exclusively to experienced investors who are classified as either sophisticated investors, high-net-worth individuals or professional investors and have the knowledge and experience to make their own investment decisions. Investments are high risk and illiquid, your capital is at risk and returns are not guaranteed. Bonds are not protected by the Financial Services Compensation Scheme (FSCS).
Originally published 8th July 2019, updated 9th January 2020.