Expert view: The arithmetic of sound investment

Over long periods of time, equities have been a splendid asset. There is no magic at work; steadily rising dividends simply make ordinary shares worth more and more.

The snag is the unpredictability of markets, which precipitates corrections that can slice up to 40 per cent off the value of a portfolio. It can take years before such losses are recovered.

At all such times, advisers proclaim that the outlook is quite different to anything they have seen before, but leave their clients with painful decisions. Should worried trustees sell their charities' shares to stop further short-term pain? If they do so, how will they decide how and when to invest again? Confidence seems to return only after prices are firmly back on their feet.

Many trustees of charitable bodies employ traditional investment advisers. By traditional advisers, I mean those who try to forecast switches out of equities into bonds or cash and back again. In effect, they try to manage a sort of equity and bond seesaw.

People in this camp must be asking themselves what to do with their portfolios after nearly four years of rising prices and recovery to the levels of 2000, after which equity market prices fell by 50 per cent over three years.

The general consensus in the market is that shares aren't, on average, over-valued (although some of the private equity targets may be) and the buoyancy will continue. But problems come out of the blue. Who knows what is going on under the financial surface, or what social tensions will break out anywhere in the world at any given moment to affect your share price?

One effective steady-as-you-go approach is to divide your portfolio into two funds: a protection fund that is almost bomb-proof and a growth fund that is unlikely to recede by more than 40 per cent in the most worrying conditions. A 37:63 split virtually guarantees 75 per cent security of capital at the height of a storm. This figure increases steadily if the original proportions are maintained in a rising market.

This dynamic approach, which can, of course, be modified as one goes along, offers a great deal of safety while reaping the benefits of further rises in share prices.

Key points

- The unpredictability of share markets means that corrections can slice up to 40 per cent off the value of a portfolio

- Divide your portfolio into two funds: a protection fund and a growth fund

- A 37:63 split virtually guarantees 75 per cent security of capital

- George Lynne is new business director at PSigma Investment Management.

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