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23-year-old investing to buy a house

Our experts think this young investor has made a good start but needs to set clearer goals and consolidate his holdings
July 12, 2013 & Patrick Connolly

Nick is 23 years old and has been investing for two years. He aims to generate sufficient capital to buy a house before he is 30. He has no debts and works for a UK stockbroker.

He says: "I've tried to focus my attention on careful asset allocation. In March I reduced my exposure to the UK, in particular selling Invesco Perpetual High Income which I believe has become far too big, and increased my holdings in Asia and emerging markets. At the same time, I bought two Japan-focused investment trusts. I also diversified my UK Equity Income holdings between three different funds, each with different objectives which I hope compliment one another reasonably well.

"I think I'm able to take on more risk than most, as I don't need the money I have invested to pay bills. My biggest monthly out-going is rent - hence my desire to buy a house and pay off my own mortgage rather than someone else's. I'm also aware that my 'human capital' provides some extra protection and I try to save as much as I can each month."

Reader Portfolio
Nick 23
Description

Saving to buy house

Objectives

Funds portfolio

NICK'S PORTFOLIO

InvestmentISINQuantityPrice (p)Value (£)
Aberdeen Emerging Markets A AccGB0033228197168533.31£895
AXA Framlington UK Select Opps R AccGB0003501581252,556£639
Baillie Gifford JapanBGFD169342£577
Blackrock European Dynamic A AccGB0000495209311320.6£997
Newton Real Return IncGB0006780323423282.35£1,194
Newton Asian Income IncGB00B0MY6Z69766184.89£1,416
db x-trackers Stoxx Global Select Dividend 100 UCITS ETF IDXGSD361,896.25£682
Franklin UK Mid Cap A IncGB00B3ZGH246254404£1,026
iShares FTSE 100 UCITS ETFISF104622.53£647
iShares MSCI Japan GBP Hedged UCITS ETFIJPH74040£282
JOHCM UK Equity Income A GBP AccGB00B03KR500213244£519
Legal & General US Index Trust R AccGB0001981215470239.3£1,124
M&G Optimal Income Fund R AccGB00B7FM9R94421107.3£451
Schroder Income Maximiser A AccGB00B0HWHK7574080.63£596
Unicorn UK Income A IncGB00B00Z1S94169201.79£341
Cash Isa @ 4.25%   £3,400
Total   £14,786

Source: Investors Chronicle. Price and value as at 3 July 2013.

 

Chris Dillow, Investors Chronicle's economist, says:

In a rational world, intelligent young people with good jobs wouldn't need to worry so much about house prices. And if they did, there would be a simple solution; there'd be a big, liquid market in house price futures, so anyone wanting to buy a house in the future could invest in these and thus insure themselves against rises in prices before they buy.

But we don't live in a rational world. Hence your problem.

Ordinarily, I'd have no big argument with this portfolio. I would, though, warn you that there's less diversification within it than you think, simply because funds are highly correlated with the general global market and hence with each other.

However, if you're hoping this will help you buy a house in future, there is a problem. The correlation between changes in house prices and changes in shares is low and, on some measures, negative. For example, looking at three-year changes since 1987, the correlation between MSCI's world index (a reasonable proxy for your portfolio) and Lloyd's house price index has been minus 0.29. This tells us that there is a big danger that your portfolio won't protect you against rising house prices, and could even fall as house prices rise; this happened, for example, between 2000 and 2003.

In this sense, this portfolio - while reasonable in most regards - seems poorly equipped to do what you want it to.

How big a problem is this? Three things make me think it's not.

First, that negative correlation could work in your favour. It tells us that it's quite possible that share prices will rise while house prices fall, giving you a double victory. Many people would think this quite likely, given that house prices seem expensive by historic standards. Unfortunately, they've been saying that for years.

Secondly, are you really so desperate to buy a house? Sure, handing money over to a landlord is unpleasant. But handing it over to a bank isn't something most people do with a joyful heart. Rushing into home ownership can be a bad idea; having negative equity in a horrible flat in a bad area is no fun, as some of my contemporaries who bought during the 1988-89 boom will testify. And there are advantages to renting; it allows you to move more cheaply and quickly, and it frees you from all the hassles of maintenance that come with ownership. So, look again at the merits of renting. If we can't adapt the world to fit our preferences, why not adapt our preferences instead?

Thirdly, you have a much bigger asset - your human capital. If you're like most 23-year-olds, this should, with average luck, appreciate over the next few years. For you, therefore, the ratio of house prices to earnings could fall thanks to the latter rising.

And herein lies the most important point. For younger people, how much you earn and save is more important than the details of what exactly you put your savings into. The very fact that you have a good job and are saving and investing means you're doing the right thing. And if this isn't good enough, then the country has a problem, not just you.

 

Patrick Connolly, a certified financial planner with Chase de Vere, says:

It is commendable that you have set yourself the goal of being able to afford a deposit on a property by the time you are 30. At the age of 23 you are making good progress toward this. So that you can keep track of whether you are on target you must also give some thought to the type of property you would like to purchase and size of deposit you would need to accumulate. This will give you a real, quantifiable target.

While you are focused on getting onto the property ladder, there may be other short- or long-term priorities that you mustn't neglect also. You may, for example, have plans to get married and have children before you are 30, and also should ideally be looking at pension planning before that age.

As you are young, you should, in theory, be able to take a long-term time horizon and so invest in growth assets such as equities. However, you need to have some control over the risks you are taking as you are only looking at a seven-year time horizon. As this time period reduces you will need to give more thought to reducing risks.

You have achieved a really good balance by having an understanding of something that many more experienced investors fail to implement, and that is the importance of asset allocation.

You have built a decent spread of assets including a cash Isa paying an incredibly competitive rate of interest in the current environment, equities with a wide geographical spread and holdings in fixed interest and absolute return.

You hold a number of good quality actively managed funds which we also use in some of our client portfolios including: Aberdeen Emerging Markets, AXA Framlington UK Select Opportunities, BlackRock European Dynamic, Newton Asian Income, M&G Optimal Income and Newton Real Return. You have sensibly combined this with low-cost passive funds, investing in both trackers and exchange traded funds (ETFs).

However, you have too many funds in which you have too little invested. I can see that you are trying to achieve adequate diversification in many regions but that said, there is little real benefit in selecting a great quality fund which rises by 10 per cent if you only have £300 invested in it.

As you are building your portfolio I suggest that either you focus on a smaller number of actively managed funds or consider more generic, multi-asset or multi-region funds or passive funds. As your portfolio gets larger you can look to increase the number of actively managed funds you hold if this is appropriate at that time.

You don't seem to have a real process to determine how much you are going to invest each month. The danger is that some months you might invest very little or nothing at all and if you do that you can more easily slip behind your target. If getting on the property ladder is your primary financial goal you should ideally be more systematic about it. This will involve having a quantifiable target to hit, which should be reviewed over time, and by deciding how much you can afford to invest each month you will know what level of growth you need to reach that target.

I therefore suggest you focus on paying regular premiums into a much smaller number of funds. This might be best achieved by investing into a combination of UK, US, European, Asian and emerging markets equity tracker funds. As fund sizes increase you can move some money into good-quality active funds or, to provide greater protection - if needed - other assets such as fixed interest and funds such as Newton Real Return.