In previous articles we have looked at the different asset classes available for investment, such as bonds, equities, property and alternatives, now we'll discuss how to best put them together.

Modern Portfolio Theory states that the best way to maximise returns and reduce volatility is through sensible and considered 'asset allocation'. In simple terms this is the art of combining assets in a portfolio so that 'all of your eggs are not in one basket'. In fact it is more like trying to have several totally different baskets all working together.

Because different assets react differently to events in the economic environment then by combining them in different proportions we would hope to reduce the volatility of our investments; e.g. while the bond part of our portfolio may be falling in value (maybe due to changing interest rates) our shares may be performing very well. 

In addition it is worth having a broad spread within the same asset class. Geographical and Sector (e.g. from different industries) diversification of shares, bonds and property is very important, though some currency risk will need to be considered too.  

Predicting the future: one of the major benefits of asset diversification is that we are unlikely to be able to predict the future with any consistency, so by having a broad spread we can ensure that we have a ‘bit of the action’ when it happens. 

Portfolio Construction: The general rule is that the longer you have to go until you require the money then the higher exposure you can have to the more volatile asset classes, like equities. As you approach the time that you will need the money (maybe as a lump sum or to start drawing an income) the more you should move the money into lower risk assets like cash or bonds. If you will be taking income for a long time then it is still sensible to have some exposure to growth assets in order to try and maintain the value of the portfolio as you remove income.

 There are asset models available from different investment companies and fund advisory bodies, or your personal adviser should be able to discuss the design of your portfolio with you.

 By far the easiest way to build a very diverse portfolio is via investment funds. The choice of funds is now enormous and nearly every asset class is covered by them. This means it is very easy and inexpensive to put several funds together and have a very broad spread. There are now some very good 'multi asset' funds which provide exposure to all of these different classes in one professionally managed place. These multi asset managers may also be able to access some funds which are still not available to the retail investor, such as private equity.

This article is for information only and should not be considered as advice.

Peter Brooke is a financial planner to the English speaking expatriate community. He is based on the Cote D’Azur and is a member and partner with the Spectrum IFA Group. He can be reached on +33 6 87 13 68 71 or at www.spectrum-ifa.com/riviera.html

This article was published in the July 2009 edition of Dockwalk magazine.