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Am I taking an uneducated risk?

Our reader worries that his stock picking will erode his overall performance. But our experts say there are bigger issues to consider
June 26, 2014

Jeff is 58 and is wondering if he is a "dangerous beast" in terms of investing. "I have a significant interest in financial matters, a good generic level of knowledge," he says. "However, I am beginning to suspect that I am taking too much of an uneducated risk; picking in and out of too many shares and investments, which may erode my overall performance badly. I am also under-involved in investment trusts, and am never quite sure how to balance my self-invested personal pension (Sipp) against my individual savings account (Isa).

"I expect you to say that my portfolio is too varied. I am interested in the view that: if none of your shares are a high proportion [of the portfolio], then even a large rise or fall hardly affects the overall portfolio. This makes sense, but how do I correlate that view with some degree of safety?

"I am a fan of Simon Thompson's bargain portfolio. However, my confidence has recently been knocked by some drops."

Jeff intends to live on his Royal Air Force pensions, while maximising his £230,000 portfolio of Isa and Sipp investments "for the small luxuries in life". He also wants to maximise the inheritance tax pot for his daughter.

However, in 2016 his mortgage of £110,000 needs to be repaid.

Reader Portfolio
Jeff 58
Description

Objectives

Isa and Sipp

JEFF'S PORTFOLIO

Isa holdingsCodeValue (£)%
Arden Partners ARDN3,2004
Artemis Strategic Assets R Acc GBPB3VDDQ57,1728
BlackRock Gold & General A Acc GBP5852397,3339
Camkids GroupCAMK1,9882
Deutsche Lufthansa AGLHA5,3406
GlaxoSmithKlineGSK15,02218
International Consolidated Airlines Group SAIAG8,34510
Lindsell Train Global Equity A Inc GBPB644PG020,17724
Vodafone GroupVOD11,69514
Total stock value£80,27295
Cash£4,3195
Total Isa value£84,591100

Sipp income drawdown holdingsCodeValue (£)%
1PMOPM4,3703
32RedTTR6,7655
Aberdeen Asia Pacific Equity A Acc GBPB0XWNF88,6056
Barratt DevelopmentsBDEV5,6254
BlackRock Gold & General A Acc GBP5852391,6941
Bovis Homes GroupBVS10,4997
BPBP.14,14410
Charlemagne CapitalCCAP4,0443
Dunelm Group DNLM10,6187
Falkland Oil and GasFOGL8241
Fastnet Oil & GasFAST1,9661
Glencore XstrataGLEN5,0733
HSBC HoldingsHSBA12,9489
Imagination Technologies GroupIMG2,0741
Invesco Perpetual Japan Acc GBP33028118,6426
IQEIQE5,3274
NetcallNET1,9971
Polo ResourcesPOL5,3324
Providence ResourcesPVR4,3143
PV Crystalox SolarPVCS6,4024
Real Good Food CompanyRGD2,9522
RecordREC3,3032
Taylor WimpeyTW.7,4005
Total stock value£134,91892
Total cash£11,0538
Total Sipp value£145,971100

 

Chris Dillow, the Investors Chronicle's economist, says:

You say your confidence has been hit by some recent losses. Should it be? Losses are feedback. And feedback is what we learn from. The question is: what do your losses teach you?

And herein lies the problem with investing. The feedback is noisy. Even the best investors hold some losing stocks and go through some bad patches; Warren Buffett did badly in the late 90s, for example. This makes it difficult to learn from our own personal experience, with the result that we might commit one of two alternative errors: either we get downhearted and stop investing; or we dismiss the losses as mere noise and carry on making mistakes.

Luckily, though, we don’t have to rely solely upon our personal experience. We have a lot of robust academic evidence about how to invest better. Some of this evidence seems consistent with your losses.

Research by Christopher Polk at the London School of Economics has found that the typical professional investor has only around half a dozen good buy ideas. If you’re surprised by this, don’t be. One big idea in economics is that stock markets are efficient, in the sense that share prices already embody all information. From this perspective, it’s remarkable that there are any good buy ideas at all.

This poses the question: why should you have more good ideas than the professionals? The fact that some of your holdings have lost money suggests you don’t.

You ask how to combine a more concentrated portfolio with a degree of safety. We can do so in two ways.

First, combine a few stock holdings with a tracker fund; this gives you cheap, low-cost diversification.

Secondly, we can tweak the odds of finding good stocks in our favour a little by following a few principles:

Be very wary of speculative stocks. Investors tend to over-pay for shares which offer the small chance of massive returns: this is one reason why Aim stocks have on average done badly for years. Your losses on some speculative resources stocks fit this pattern. I would temper this advice, however, by noting that sentiment towards Aim now seems unusually depressed and so it could bounce back, to the benefit of speculative shares.

Use momentum. You should do this in two ways. One is to cut losing stocks. It’s very tempting to hold on to these in the hope of getting even. But shares don’t remember the price you bought them at, and they’ve no reason to return to it. Instead, we have lots of evidence from around the world that past losers tend to carry on losing. Secondly, you should favour positive momentum; if a share’s risen recently (subject to the conditions below) this is a reason to take interest in it.

■ Favour defensives. Less volatile stocks tend to do better than they should. Again, your portfolio fits this pattern; Vodafone (VOD), Royal Dutch Shell ‘B’ and GlaxoSmithKline (GSK) have done OK for you.

■ Look for profits. There’s evidence that companies with growing profits tend to deliver better equity returns.

■ Don’t ignore dividends. Again, research shows that value stocks - those on decent yields - tend to out-perform. However, this might be a reward for taking on recession risk; higher-yielders did atrociously during the 2008-09 financial crisis.

Now, you’ll notice the word "tend" appears a lot in all this. This is because no stock-picking method is 100 per cent accurate. All I can do is point out what works on average over the long run. To use a golfing analogy, you’re more likely to hit a long drive if you have the wind behind you. But even with a favourable wind, you still might shank a few shots.

 

Helal Miah, investment research analyst at The Share Centre, says:

Before looking into the allocation of your portfolio we must consider the very important issue of your mortgage. As it is expected for repayment sometime in 2016, I would consider this a relatively short term and very significant liability. I don’t know whether you plan on re-mortgaging or using the investment assets to pay this off. However, if it is the latter, I would say that you are employing a higher-risk strategy, despite the fact that there is a large buffer, with your equity portfolio being far larger than the mortgage liability. The sound strategy would be to put aside some capital to cover the mortgage into safer assets. However, I do understand the low yields in fixed income assets as the key driver to your decision. I believe at the moment the equity market is the best place to generate returns for the next couple of years, but for unhindered capital.

Looking at both yours and your wife’s portfolios I agree with the allocation you have made to funds, making up roughly a third of your portfolio. Among the funds you have covered most of the key asset classes and geographical regions, including exposure to the world's largest economy.

While you have a good number of different stocks, I would say that overall the selection could be a little more diversified. For example, over 15 per cent of the 17 per cent exposure to commodities is focused towards oil & gas, leaving Glencore Xstrata (GLEN) as the only diversified miner - and even this has a large exposure to the energy market. I like Royal Dutch Shell ‘B’ for the income it offers and BP for both its income and longer term prospects. However, I think you have more than enough holdings in different smaller oil & gas exploration stocks, despite your higher-risk attitude. If you wanted to keep to the basic resources theme, then I would suggest that over time you consider focusing more on exploration away from oil and gas into other mined commodities. While energy prices remain elevated, helped by political risk, I think the current weakness in other commodities presents greater opportunity in the longer term.

Given your growth focus, your equity allocation suits your objective, with big blue chips accounting for roughly 30 per cent of the portfolio and the rest in mid to small caps. You have a focus towards technology and niche retailers and I can see a bias towards house builders. Despite interest rate rise uncertainties, I am quite happy with your investment in this sector because I believe the lack of supply of housing stock in the UK is the more important driver.

Your portfolio has just about the right number of different investments. I feel that around 30 stocks should be able to cover most sectors, market caps and geographical exposures. Anything more could become unwieldy and require more energy to track the drivers of the individual stocks. I share your views regarding spreading yourself too thinly where individual stocks movements do not really impact the portfolio, taking away some of the fun of investing. However, let’s not forget that by having more stocks you do not eliminate risk entirely. Market risk will always exist even if you lessen the stock specific risk.