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Investing early to buy a house

Our young reader's holdings suffer from a lack of diversification
January 21, 2016, Adrian Lowcock and Jason Witcomb

Andrew Baker is 23 years old and has been investing for three years. He is investing for growth and ideally would like to use his investments to help buy a house, although adds that as he works and lives in London this may not be possible.

Reader Portfolio
Andrew Baker 23
Description

Isa and peer to peer lending

Objectives

Buy a house

"I intend to maximise the growth of my portfolio and do not intend to use the money for at least another five years. I started off with £5,000 and have added to it every year after that. The initial £5,000 was used to buy five funds, putting £1,000 into each, and I have tried to diversify where possible.

I have used funds more than individual shares as I am very busy, and due to the small amounts of capital I have had to invest my gains would be quickly negated by the trading costs of investing in shares. However, this year I intend to start investing in individual shares to compliment my current portfolio, as well as adding other funds.

Given one of my goals is to buy a house I have tried to get exposure to property performance through a tracker.

Where possible, although boring, I have used passive funds as I understand that the majority of the time they beat actively managed ones.

I am also a fan of micro businesses and the growth opportunities associated with these.

I have £2,000 invested in peer-to-business lending site Funding Circle and this yields approximately 7 per cent.

I roughly save £500 a month from my salary into investments. I tend to split this after half a year 25 per cent/75 per cent between Funding Circle loans and my investment account, which is a stocks-and-shares individual savings account (Isa).

I am open-minded on risk and happy to take on more given that I am trying to balance my portfolio. I do not need instant access to this money, so am in a position to benefit from the effect of compounding, and can disregard day-to-day movements to take a longer-term view.

Although I am young, I believe I have an understanding of investing and the risks associated with it.

My last three trades were all buys: BlackRock Global Property Tracker (GB00BPFJCF57), 400 further units in CF Woodford Equity Income* (GB00BLRZQC88) and Morgan Stanley Corporate Bond (GB00BHZ7N839).

 

Andrew's portfolio

HoldingNumber of shares/units heldValue (£)% of portfolio
BlackRock Corporate Bond 1 to 10 Year (GB00B84DT147)1,1611,51711
BlackRock Global Property Securities Equity Tracker (GB00BPFJCF57)1,6812,60118.8
CF Woodford Equity Income (GB00BLRZQC88)1,3971,73012.5
HSBC FTSE 100 Index  (GB00B80QFR50)9101,59111.5
M&G Global Dividend (GB00B39R2Q25)5359927.5
Marlborough UK Micro Cap Growth (GB00B8F8YX59)3421,66612
Morgan Stanley Sterling Corp Bond (GB00BHZ7N839)1,4141,53411.1
Newton Asian Income (GB00B8KT3V48)5678736.4
Unicorn UK income (GB00B9XQFY62)5491,3129.5
Total

13,816

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You're doing a lot right here. For one thing, you're starting young. This doesn't just allow you to benefit from the power of compounding. Assuming we get average luck with future equity returns, it also means you're getting into the habit of saving and investing.

I also like your efforts to detach yourself from day-to-day price moves. Most of these are noise rather than signals. It's important not to get downhearted by short-term market falls: it's easy to sell at the bottom.

I applaud your preference for passive investing. The point here isn't just that passive funds beat active ones on average: this doesn't always happen. If, as has been the case recently, large stocks underperform small ones, then tracker funds would also underperform. Rather, trackers have two other virtues.

One is their low fees, something that matters for long-term investors as fees compound over time. In the absence of a strong reason to presume that small-caps will continue to outperform large-caps over the long run, this is a reason to prefer trackers.

The other is that, in the long run, even well-established firms are vulnerable to unpredictable creative destruction. You might well outlive many apparently blue-chip companies. For this reason you should back the field rather than particular horses, and the cheapest way to do so is with trackers.

This, however, brings me to a cautionary note. You say you're a fan of micro businesses, but investing in these is dangerous because very many fail. If you want to buy into them don't do it directly. Instead consider a private equity investment trust.

 

Adrian Lowcock, head of investing, AXA Wealth, says:

You recognise that risk is an important factor to take into consideration when it comes to investing. However, to be able to determine the type of risk you are comfortable taking it is important to know what you are investing for: having a clear goal is an important starting point. In this case I feel you are trying to balance two goals: saving for a deposit and broader long-term investing. You need to decide what your focus is.

It would help you to focus on your goals if you researched how much buying a home would cost, how much you need and how long it will take you to reach that goal. Knowing if a goal is achievable and realistic is essential. You then need to work out how big the gap is between your savings and your goal, as this may influence how much risk you should take.

For example, if you save £500 a month, after five years you would have an extra £30,000 excluding any interest, over and above your existing savings of around £16,000. This simple calculation should give you a good idea of how long you will need to save for.

 

Jason Witcomb, certified financial planner and director at Evolve, says:

I would like to congratulate you on taking an active interest in personal finance and committing to a regular savings programme at such an early age.

Given that one of your objectives is to save for a deposit to buy a house, you might like to consider a Help to Buy Isa as part of your savings strategy. Under this scheme you can save £1,000 initially then up to £200 per month. At the point you buy a property as a first-time buyer you can get a 25 per cent bonus from the government. The maximum bonus is £3,000, which would increase a £12,000 savings pot to £15,000. As you can appreciate, with a £200 per month cap, the earlier you start the more likely you are to reach the maximum £12,000 figure. These are cash Isas, so you can still pay in to your stocks-and-shares Isa over and above this. The best interest rate for a Help to Buy Isa that I can find at time of writing is Halifax at 4 per cent a year variable.

 

HOW TO IMPROVE YOUR PORTFOLIO

Chris Dillow says:

Your portfolio is exposed to recession risk. In the event of an economic downturn, you might make losses on M&G Global Dividend Fund (GB00B39R2Q25) as this is heavily weighted to cyclical materials stocks. You might also make losses on your corporate bond funds and peer-to-peer lending, because defaults, or the risk of them, rise in an economic downturn. This matters because it's possible that in such an event you'd also lose your job, meaning that you might have to sell your investments at depressed prices to tide yourself over. You must try to avoid this danger: never be a forced seller.

There is an argument for holding some cash, and there might also be a case for preferring gilts to corporate bonds.

You face a further risk that applies to all of us, but which is especially nasty for a younger person: the danger that we fall into secular stagnation. This is a sustained period of low economic growth in which equities do badly for years: think of Japan's so-called 'lost' decades. If this happens, the advantage of youth - that you can profit from the power of compounding - becomes a disadvantage.

We can't quantify this risk, but even the small danger of a nasty event must be considered. One way to address it is to hold some assets that aren't so sensitive to growth, such as cash or gilts. A more risk-tolerant way to tackle it is to diversify globally, in the hope that some parts of the world will escape stagnation.

 

Adrian Lowcock says:

You have linked some of your investment decisions with your goal by putting property investments at the core of your investment strategy. But the reason for investing shouldn't drive the underlying asset allocation decisions - a global property tracker fund is unlikely to match the performance of the local housing market. As such I would look to reduce the exposure to property by adding to some defensive assets such as Newton Real Return Fund* (GB00B8GG4B61).

Exposure to peer-to-business lending may look attractive considering the high interest, but a yield of around 7 per cent strongly suggests you are taking on a high level of risk. The problem with many peer-to-peer lending sites is that the amount of information you can obtain on the financial strength of the businesses is limited, which could mean you are taking on more risk then you realise. I would suggest this holding is not increased, or even reduced, in favour of more transparent investments.

With regards to the portfolio, there is a lack of diversification in the types of investments you hold. There is a small global fund, but beyond this the equity funds are mainly focused on the UK with some Asian exposure, while the other assets are invested in corporate bond funds and property.

For a portfolio of this size I would suggest a core global fund around which you could add satellite investments. I would also suggest adding exposure to European and Japanese equities, where on a relative basis they look more attractively valued.

With regards to the corporate bond funds, I would switch these to more flexible funds. Given that the sector is likely to come under pressure from rising interest rates and that you do not need income, I would go for BlackRock Fixed Income Global Opportunities Fund (GB00B8DCRV88), which is well placed to produce a positive return in all market conditions.

 

Jason Witcomb says:

You are aware that costs are an important factor in investment decisions and you are right in thinking that the majority of actively managed funds fail to deliver. However, it's not simply a question of active versus passive, but rather a question of low cost versus high cost: there are also plenty of overpriced tracker funds.

All holdings within a portfolio should have a clear purpose. Some of your funds charge in excess of 1.5 per cent a year, whereas you could buy a global tracker fund for less than a tenth of the price. Do some of your funds fulfil a role that justifies this extra cost?

With charges of just 0.15 per cent a year, Vanguard FTSE Developed World ex-UK Equity Index Fund (GB00B59G4Q73) would seem like a good benchmark for you to compare current equity holdings and future fund purchases against.

Buying a fund such as this as a core holding would give you much greater global diversification and would have a positive impact on the cost base of your portfolio. I don't subscribe to the view that tracker funds are necessarily boring - the biggest two holdings within this fund are Apple (US:AAPL) and Alphabet (US:GOOGL), better known as Google, which I think most people would describe as exciting companies.

Remember that diversification is not simply about adding more holdings: for example, one global fund gives you much better diversification than a dozen UK funds.

*IC Top 100 Fund