Investing to buy a house in 2016

SARMILAN'S PORTFOLIO

Source: Investors Chronicle & ft.com, as at 23 July 2014. $1=£0.59

LAST THREE TRADES

Saga IPO (bought 400 shares), Rolls-Royce (bought 105 shares), Vodafone (bought 331 shares)

WATCHLIST

RPC, Marlborough Special Situations, Vanguard Life Strategy Funds, Interserve, Babcock.

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

Shares are especially risky for an investor in your position.

I say this because you want to buy a house in two years' time. This exposes you to the danger that house prices will continue to rise quickly, thus putting even more properties beyond your budget. However, ordinary shares don't necessarily protect you from this danger. This is because it's possible that they will fall even if house prices rise; this happened, for example, in both the late 1980s and early 2000s. Since 1985, the correlation between two-yearly moves in the FTSE All-Share index and in house prices has been zero, which implies that shares are as likely to fall as to rise if house prices rise.

In this sense, equities are dangerous, as putting your money in them could give you the doubly nasty dose of falling share prices and rising house prices.

If you're worried by this, there's a solution. There are now residential property funds, such as Castle Trust's Housa funds and the TM Hearthstone UK Residential Property Fund. These should rise if house prices rise, thus saving you the distress of seeing your dream home become unaffordable. Sure, you'll lose money if these fall. But you'll be compensated for that by seeing housing become more affordable. Either way, you're protected.

I don't normally recommend specific funds, but unusual cases have unusual remedies.

Beyond this, however, I would urge younger investors like you to concentrate their equity investments into tracker funds, for two reasons.

To see the first, look at a list of members of the FTSE 100 when the index was first formed 30 years ago. I suspect your reaction on reading this will be: "who the heck are Ferranti, Exco and British & Commonwealth?" This tells us something important story - that a young investor is quite likely to outlive a lot of large and well regarded companies. Individual stocks are not necessarily long-term investments because some companies will wither and die. A young, long-term investor should therefore hold a core of tracker funds because doing so saves you the hassle of trying to pick long-term winners. Why back specific horses when you can back the field?

Secondly, stock-picking requires time and effort. Research tells us that most retail investors underperform the market: your experience with Carclo isn't unusual. There's a danger that having suffered a few losses (as all investors do sometimes) you might decide that investing is not for you and so get out of the habit. This is especially costly for younger people because if you stop investing you'll lose the most powerful friend an investor can have - the power of compounding. One of the best ways of getting rich is simply to start saving early and watch returns compound. For example, if real returns are 5 per cent a year (a reasonable working assumption for equities), then you if you want £100,000 by the age of 60 you need to invest just under £1,500 a year for the next 30 years. However, if you start investing when you're 40, you'll need to save almost £3,000 a year to get that £100,000.

In starting saving so young, you've done yourself a massive favour. Keep doing it. One way not to be disheartened is to invest regularly in tracker funds, because doing so means you'll not underperform the market by much.

You might object that investing in trackers is boring. It is. But many things are boring if done well, as those of us who remember watching Geoffrey Boycott bat will tell you. (Ask your dad.) By all means buy an individual stock or two. But think of doing so as a dabble and a learning experience, not as the centrepiece of your investment strategy.

Ben Yearsley, the head of investment research at Charles Stanley Direct, says:

I am afraid I am going to be slightly harsh. It is great that you want to invest and are prepared to take risks with your money in order to build up a bigger long-term pot. However, to put it bluntly you have your timescales totally wrong.

You have stated you would like to invest £30,000 over the next few months, but that you want the money back in 2016 in order to use it as a deposit for a house. If that's your plan, my simple suggestion is: don't invest. Many people think that the stock market is a way of making a 'quick buck', it isn't; it is somewhere to invest for the long term. Quick profits can be made, but that is more down to luck. If you are relying on your money in the short-ish term for something as important as a house purchase, then please don't invest in the markets. Your quick profit could equally as easily turn into a quick loss. If you are looking at a sum of £30,000 and need it in two years, Premium Bonds from NS&I are a sensible, if boringly safe place to put the money. Premium Bonds are available to Channel Islands residents in addition to residents of the UK. However, you will need to have an account with a UK bank or building society.

If you decide you can postpone the house purchase for a few years and tie your money up for longer, then that does open up many more possibilities. Equities could and should then be considered. You have a reasonable sum to invest and clearly like the idea of holding shares direct, but also of collective investments such as unit trusts. Therefore, you could combine the two and have a core of fund holdings, and then add some spice around the edge with shares. If that was the desired route then investing two-thirds into funds and one-third into shares seems appropriate - as both will give you a reasonable level of diversification. I always suggest if buying direct shares you should aspire to having 15-20 different companies in your portfolio. Having less than this dramatically pushes up risk.

On the fund side, you mention Marlborough Special Situations (GB00B659XQ05) and the Vanguard Life Strategy Funds - two very different types of investments. You mention you are moderate on a risk tolerance scale so, despite being an excellent fund, I think the Marlborough fund might be too risky for you. However, if you really do have a moderate attitude towards risk, why are you investing in individual shares? On the fund side maybe you should be looking at some core holdings such as the Jupiter Merlin Income Portfolio (GB0003629374) or Jupiter Merlin Balanced Portfolio (GB0031845141) or maybe the Henderson Multi Manager Funds - these multi-manager funds provide a diversified base upon which other investments can be added.

If you are happy with the higher risk of individual shares, you should look to build a portfolio of 15-20 shares as a minimum. You already have Rolls-Royce, one I was going to suggest, but you might want to consider InterContinental Hotels (IHG) and Sports Direct International (SPD) as well. With InterContinental Hotels, the valuation may be high, but long-term prospects are substantial - especially with its move into China. The business model is low cost - as it is mainly a franchise structure with other companies owning the buildings and IHG providing the management teams. Sports Direct hardly gets any sales off the internet - but it is now investing in the online market both here and aboard. It could be an interesting opportunity, although it is not a dividend payer.

Clearly, my comments on funds and shares are only relevant if you are prepared to invest for the long term, and not just for the next two years.