How do big financial services companies invest their money?

Our services are based on the same techniques that big financial services companies use to manage their own money. We are the only people making this type of commercial-grade technology available directly to consumers via our comparison tables and our free CushonMe investment monitoring service.

The overriding principle is that no-one knows what is going to happen in the markets. Overall, they're more likely to go up (particularly in the long term), but they might also go down. It's just a question of probabilities.

This is different to what you might think from reading the financial press. Many commentators will express opinions on the attractiveness or otherwise of particular segments of the market. For example, a recent story in one of our competitor's newsletters read: "Many Investors overlook Europe, but we believe it represents a compelling opportunity" .

This makes for interesting headlines, but the reality is that they don't know (if they did, they wouldn't be writing financial columns). The big financial services companies don't pay much attention to commentators trying to predict the future. Their approach is a lot more boring:

1. They recognise that, over the longer term, the returns on stocks and shares are likely to be significantly higher than the returns they could get on cash. This is a well-recognised effect called the "risk premium" (because it's the investor's compensation for taking some risk).

2. They decide how much risk they can afford to take by looking at how much they stand to lose if markets fall. This is often called a "risk budget" or "risk appetite" and is expressed in terms of an amount, a probability and a time period. For example, they might say "the probability of a loss in excess of £20m over 30 days must be no higher than 1 in 25". Our CushonMe risk alerts are based on similar principles but translated into something a bit easier to understand.

3. Given their risk budget, they try to diversify their portfolios as much as possible, because they don't expect to earn any risk premium for risk that could be eliminated by diversification.

4. They also seek to invest as cheaply as possible, because they know that higher costs eat into returns over time. Some investment managers claim that their skill in managing investments more than compensates for their charges, but most independent studies conclude that this is not the case.

These principles are brought together in sophisticated financial models which analyse the markets and come up with optimised portfolios, designed to maximise the likely returns, given the organisation's risk budget. The portfolios in our comparison tables are derived in the same way.

The investments are then reviewed frequently (usually at least daily) to ensure that the level of risk remains within budget and that the portfolios are still close to being optimal. Our free CushonMe investment monitoring service gives you an equivalent of this daily review.