Diversify and look for momentum

"My wife and I have £1,000 a month to invest towards this, which will double to £2,000 a month for the last two years once our mortgage is repaid," he says. "We are tied into our mortgage for the next four years at 4.99 per cent which carries a hefty penalty for switching.

"We do not have any children. We would like to retire early, ideally without downsizing our home, although we could downsize and release around £100,000 for our retirement pot if it made the difference between retiring early or not.

"We both work full-time and our earnings are our only source of income. We have no cash or other investments other than the equity in our home. We don't save cash because interest rates hardly protect its value over time. We are both civil servants so wouldn't lose our income overnight in situations such as bad health. We budget well and if we have unforeseen expenditure we put it on our credit card and pay it off the next month, when we save less.

"I am open to risk as I am 10-plus years away from needing my income or capital - the reason why my portfolio includes risky growth stocks. Most of my portfolio is sitting at a loss, which doesn't worry me too much in the short term. I am sat on a paper loss since I started trading: past profits and losses, plus my current portfolio loss, equal a loss of around £7,000 to date.

I expect my attitude to risk to change as I turn 50 and get closer to retirement. At this point I will be looking to safer shares and dividend income, with less focus on capital growth. At the moment dividend income is not important, although I reinvest in more shares where I can, as I appreciate the power of compounding.

"My first trade was buying Barclays (BARC) shares over the months of the financial crisis on the basis that they were too big to fail - and we all need banks. Every time they went down I bought some more, thinking it was the obvious thing to do. I invested around £5,000 and sold them for around £9,000. This led me to think that I had found my true vocation in life, so my philosophy became looking at five-year charts and buying big companies that appeared to have gone down substantially.

"I now realise, having since bought the likes of Debenhams (DEB) and Premier Foods (PFD), that it's not as simple as that, and that I was lucky with Barclays. I now read and think a lot more before making a trade.

"My last three trades were buying another 500 Poundland (PLND) shares at £2.16 because they tanked due to the 99p Stores not being ready for Christmas, which is surely a short-term issue. And every time I pass my local Poundland there's a big queue!

"I bought another 350 Rolls-Royce (RR.) shares at £5.49 on the news that an activist investor had upped its stake. And I sold 200 GlaxoSmithKline (GSK) shares at £14.01 on the news that Hillary Clinton might impose price caps, and after reading that too many protected lines are soon to open up to generic competition. I have the following shares on my watchlist:

Fevertree Drinks (FEVR)

HomeServe (HSV)

Dunelm (DNLM)

Lloyds Banking (LLOY)

Rentokil Initial (RTO)

Our reader's portfolio

Source: Investors Chronicle

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

This portfolio is pretty much exactly the opposite of what I would usually recommend, in two senses.

First, it is biased towards risky growth stocks, the main exception being Rio Tinto (RIO) which is a risky ex-growth stock. This is a problem because history tells us that such stocks tend to underperform on average over the long run.

One reason for this is that investors tend to overestimate their ability to foresee growth, and underestimate its sheer unpredictability. This is partly down to overconfidence. But it can also be because they underweight the power of competitive market forces.

For example, you say you're bullish of Poundland because there are big queues outside your local store. But do such queues really show that Poundland has growth potential? Or do they instead show that there's an opportunity for rival discount stores to open, and take customers from Poundland?

Warren Buffett has said: "I don't want a business that's easy for competitors. I want a business with a moat around it." What he means is a way of keeping potential rivals out of its market. So what is Poundland's moat? Or Tungsten's (TUNG)? Or Boohoo's (BOO)?

My second problem is that there's lots of negative momentum in this portfolio. In fact, three of your holdings are members of my negative momentum portfolio: Rio Tinto, Aggreko (AGK) and Poundland.

This matters because negative momentum stocks perform horribly on average. Since I began it in September 2011 my negative momentum portfolio - the 20 biggest fallers in the previous 12 months among stocks with a market cap above £500m - has halved, while the FTSE 350 has risen 22 per cent. This tells us that, on average, stocks that have fallen continue to do so, at least for a few months.

One reason for this is that their holders are often like you: they cleave to the hope of a turnaround so don't sell the share, causing it to be overpriced in the face of bad news with the result that it falls further later.

Now, I'm not sure this means you should sell these stocks. Maybe they will beat the odds and turn around, or at least benefit from a short squeeze at the first hint of optimism. You should, though, ask: if I didn't own them, would I buy these stocks now? The disposition effect - hanging on to losers in the hope of getting even - is a common and costly error. Avoid it.

Peter Day, partner, Killik & Co, says

Taking into consideration your investment time horizon, risk tolerance and investment goals, I believe that investing a large proportion of your entire portfolio into equities is the most appropriate strategy. While equities will undoubtedly experience a great deal more volatility than other asset classes, over long periods they have consistently delivered higher real returns than all other asset classes. Over the very long term, equity markets have returned around 5.1 per cent a year above inflation.

Based on the value of your portfolio of about £32,000, and your planned monthly investments of £1,000 for nine years and £2,000 for two years, you would require a compounded annual return of around 4.7 per cent in order to achieve your goal of a £250,000 portfolio value by the age of 55. This is certainly achievable, although by no means guaranteed. I would like to add that due to the effects of inflation, your £250,000 portfolio will have less purchasing power in 11 years' time than it would today - this should be taken into consideration when planning for future retirement.

In order to achieve your investment target, I would encourage you to build a well-balanced and diversified portfolio, ensuring that you maintain exposure to a number of different sectors and geographies.Your strategy of feeding money into the market on a monthly basis will work in your favour as you do not need to worry about market timing - and you will benefit from the effect of pound cost averaging.

Louis Coke, investment manager at Charles Stanley, says:

You have a good foundation for your investment strategy in that you have quite a clear idea of what you are looking to achieve, and you have the advantage of being able to contribute funds to the portfolio every month, thereby being able to take advantage of pound-cost averaging.

In terms of achieving your goal of having £250,000 by age 55, let us go over the numbers briefly first. The current value of the portfolio is £32,048 and, based on the details given, an additional £168,000 will be added over the next 11 years. This gives a total value, assuming no growth, of around £200,000. Making a simplistic calculation, the portfolio then needs to grow by at least 4 per cent a year net to hit that target. This gives us some idea of the risk the portfolio has to take to achieve its stated return.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

I'd suggest three changes to your approach. First, think more about momentum. We know that past winners keep rising and that past losers fall on average. You can use this fact positively, by including positive momentum as one quality you look for in a share. Or you can use it negatively, to sell losers. One useful guide here is whether a price is above or below its 200-day moving average.

Secondly, think less about future growth - which is unknowable - and more about what can be known. In picking stocks, look for Buffett-type moats. These are more likely to be found among bigger stocks that have powerful brands or big capital requirements which can exclude potential rivals. These are one reason why defensive stocks tend to outperform on average.

Thirdly, don't bet everything on your stockpicking ability. It's very easy to invest regularly into a tracker fund via direct debit. And a tracker fund's benefits include a hedge against stockpicking failures.

But there is one big cause for optimism here. Given your savings plans you should achieve your target of £250,000 by the age of 55 if equities offer the same returns in future as they have in the past - that is, around 5 per cent per year in real terms. However, this requires that your portfolio at least matches the market's performance. I'm not at all sure that it will unless you change your approach.

Peter Day says:

Having reviewed your current portfolio, it seems that your core investments are in large-cap FTSE 100 companies alongside several speculative small-cap companies. Although it is tempting to invest in the next hotly tipped small-cap, my personal opinion is that private investors should focus on high-quality large-cap stocks and funds. Successful small-cap investing is extremely difficult and time consuming: even professionals who have a team of analysts to support them struggle to make superior returns and it can prove to be a minefield for less experienced investors. If you had invested into Tungsten and Boohoo at their initial public offering prices you would be showing significant losses.

You have a very concentrated portfolio with exposure to only a handful of sectors, and all the holdings are UK listed. You would benefit from adding some technology stocks to your portfolio. We believe Apple (AAPL:NSQ) is currently looking cheap at the $100 level, with recent rumours about a slowdown in sales overplayed. Consider gaining some exposure to European and US equities, perhaps through a global equity fund such as Fundsmith Equity (GB00B41YBW71)*. This fund has around 58 per cent exposure to US equities and around 15 per cent to European equities. The long-term performance has been very strong, with the fund returning 64.7 per cent over the past three years. We like manager Terry Smith's approach to investing and this will add a much needed level of diversification to your portfolio.

Louis Coke says:

My initial thoughts would be to significantly broaden the portfolio, both in terms of the number of holdings, and the asset classes involved. For a mandate of this type I would typically include several asset classes, divided between lower-risk assets - bonds, property and infrastructure - to aim for a relatively stable return; and higher risk assets - UK and international equities, and alternative assets - to aim for a more volatile and hopefully higher return. I would not allow any one individual equity holding to account for more than 10 per cent of the total of the entire portfolio. In the current market I would prefer some of the holdings to have a reasonable yield component to them, thereby helping the portfolio's total return in flat or declining markets.

Some diversification away from retail may also be desirable. While I agree that there may be some stock-specific situations in the sector that look interesting, one must always consider the risk/reward balance. Our economic recovery is by no means certain and the high street is a rapidly changing place. A stock screening program can open the mind somewhat to undervalued or out-of-favour sectors in the market. Also, I would not be inclined to be in the small-cap exploration end of the oil & gas market, but only the large-cap, diversified end with the likes of BP (BP.) and Royal Dutch Shell (RDSA). While I do foresee some recovery in the oil price, as the old saying goes, the market can stay irrational, eg lower longer than you can stay solvent. Smaller companies will find this environment more difficult than their larger counterparts.

You and your wife may also wish to invest through an individual savings account (Isa) wrapper to make the most of your annual allowance (£15,240 each), and so that the income from the portfolio can be taken without any further tax being payable after withholding taxes.

*IC Top 100 Fund