Having established the level of relative risk that is appropriate (based on your personal circumstances) it is vital to provide suitable methods for managing the risk throughout the period.

Investment risk is reduced by spreading the investment over a wide range of underlying assets. This can be conveniently and cost effectively achieved through investment in “collectives”. These are investment portfolios managed by professional fund managers based on a particular profile or remit e.g. “UK Equity Growth”, “Overseas Bond” or “Emerging Markets” etc. Within each collective fund the underlying portfolio will often consist of 100 or more holdings in a wide variety of companies thereby providing a high level of diversification. Each fund manager’s job is to identify what securities to buy or sell and whether to increase or reduce the exposure to particular sectors of the market taking into account prevailing and expected investment conditions. Spreading investment across a wide range of underlying securities of a similar level of risk is known as “horizontal” diversification. It is also advantageous to diversify the portfolio “vertically” which is achieved by integrating a range of asset classes and management styles into a ‘risk graded’ structure, based on your desired risk profile established at the outset.

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Funds are graded according to their underlying asset class, investment strategy and the historic volatility of the fund price. Aggressively managed funds or funds investing in non-mainstream areas such as ‘recovery’ stocks or ‘smaller company’ shares will be more volatile and therefore carry more risk. Added value can be obtained by combining these with less risky funds to create an overall ‘blend’ that is in keeping with your personal risk profile. As time progresses the risk balance will be altered to stay within agreed levels by consolidating gains and rebalancing the portfolio on a regular basis (See next section on monitoring).

Horizontal and vertical diversification therefore creates the opportunity for you to achieve higher returns over the medium to long term without significant additional risk.

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