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No goal and inflated expectations

Our reader needs to lower his expectations and diversify his portfolio
March 29, 2016, Helal Miah & Russ Mould

Our reader is a 31-year-old property developer and buy-to-let investor who owns a property company with his wife. They have no children although they plan to start a family in the near future.

Reader Portfolio
Anonymous 31
Description

Investment account & Isa

Objectives

Capital growth

"We have an income that is sufficient so we do not need to use money from the portfolio," says the reader. "We're happy to reinvest dividends but aren't looking to put new money in at the moment, we'd rather enjoy our lives. We have a high income so are both top-rate taxpayers, but also have a high-cost lifestyle so spare cash is in short supply.

"We have a £300,000 mortgage on our £700,000 house. I have a self-invested personal pension (Sipp) worth around £25,000 and £200,000 in investments being managed by a financial adviser.

"My father began investing on my behalf when national companies started to be privatised in the 1980s.

"I also took control of my wife's portfolio around three years ago and have tried to actively manage it with varied success. I plan to transfer all of my portfolio into my wife's individual savings account (Isa) in the most tax-efficient way over the coming years.

"We are beginners with a great platform from which to build something over the long run but I don't have a particular goal for the portfolio. Unless something terrible happened I'd assume I'd pass the portfolio onto children or use it to help them in whatever way was necessary.

"The portfolio needs to grow at a rate significantly better than anything else readily available, ideally 10 per cent a year including dividends.

"I have found it quite hard to establish goals. This is partly due to the fact that I don't know what the purchase value was of the shares that were bought on my behalf. Because of this I choose to set the portfolios' value at the price on the day I took them over in 2013. Is this a mistake?

"Establishing goals is made even more difficult because stock picking seems to be a lottery - even with reasonable research - external events cannot be predicted.

"In the past few months I have become more and more disillusioned with investing in general. The world is so volatile it is impossible to be able to digest all of the potential dangers ahead. I wonder more and more, whether I should invest in what I know - property, local businesses and sports gambling - rather than in stocks and shares?

"I wonder whether I would be involved in the stock market at all had I not inherited the portfolio, and I think this contributes to why I struggle with objectives. I'm aware I need some kind of diversification from our other income which is very property heavy.

"Initially when I took over the portfolio I enjoyed the reading and learning about active trading; however, that enthusiasm has now waned. I don't have the time nor am I prepared to go into the detail you say is necessary to research a company. Despite this I like stock picking as I see how it can be exciting.

"The other reason I like stock picking is because I inherently object to the fees that many fund managers charge. However, despite my reluctance I think the right type of funds could improve my portfolio significantly and would take less management.

"We're aware the portfolio is becoming a little bloated and may be very unbalanced. Because of my property background I initially found companies with high-yielding dividends very attractive. I've since realised that although a steady income stream is nice there is far more potential in capital growth, and I would like this to become the focus of the portfolio.

"My risk tolerance is high due to my age and because I have other sources of income. However, this doesn't mean that I am looking to risk the portfolio on a gamble.

"My last three trades were purchases within my wife's Isa of BT (BT.A), Bellway (BWY) and Redrow.

"I have on my watchlist Easyjet (EZJ), Cineworld, Apple (US:AAPL) and Boohoo.Com (BOO)."

   

Our reader's portfolio

HoldingNumber of shares/unitsValue of holding (£)% of portfolio
Barratt Developments (BDEV)9325,382.37.69
British American Tobacco (BATS)2739,969.9614.25
BT (BT.A)1,1445,319.67.6
International Consolidated Airlines (IAG)3972,227.173.18
Lookers (LOOK)1,8603,029.944.33
Merlin Entertainments (MERL)5792,333.373.33
National Grid (NG.)8968,437.6312.06
Royal Dutch Shell 'B' (RDSB)3354,626.356.61
Cash451.710.65
Our reader's wife's Isa
Barclays (BARC)1,0792,070.062.96
Bellway (BWY)721,907.282.73
Booker2,7434,336.686.2
BT (BT.A)6392,971.034.25
Conviviality (CVR)8771,817.582.6
GlaxoSmithKline (GSK)304200.6
Ladbrokes (LAD)1,2231,423.572.03
Moneysupermarket.com (MONY)1,6235,282.877.55
Redrow (RDW)4341,835.392.62
Rexam (REX)4742,881.924.12
Rolls-Royce (RR.)149826.951.18
SSE (SSE)1682,396.683.42
Watchstone (WTG)1638.20.05
Total69,986.24

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

Your plan to shift money into your wife's Isa and your distaste for management charges suggest a desire to minimise these and taxes. That's good.

What's not so good are your inflated expectations. In an economy that's likely to grow by around 4 per cent per year, including inflation, a return of 10 per cent a year is unlikely. You can only achieve it by investing in very underpriced assets - and these are very risky. So lower your expectations.

You ask: "if stock picking is a lottery, should I invest in what I know?"

No. Investing in what you know means holding an under-diversified portfolio. And no knowledge can wholly protect us from macroeconomic surprises: in a recession, even good property investments would come a cropper. Spreading risk requires that you invest in what you don't know.

What's more, stock picking isn't wholly a lottery. It is to the extent that individual companies' earnings are more unpredictable than investors realise. But we know there are categories of shares which beat the market over the long run. These are: defensives, momentum and quality stocks, defined by object factors such as profits, past growth and payout ratios. These aren't guaranteed winners. But they shift the odds in your favour. And your portfolio has exposure to these via GlaxoSmithKline (GSK), British American Tobacco (BATS), BT, SSE (SSE) and National Grid (NG.) - you've got good exposure to defensives.

Does it matter that I don't know the purchase price of my stocks?"

No. Rolls-Royce and Shell might or might not recover. Whether they do so or not depends on whether investors are underpricing them now: it does not depend on how much you paid for them.

And it sometimes makes sense to sell losers, because crystallising a loss can be used to offset the tax you are liable for on other capital gains. In this context, what makes good sense for investing purposes - cut your losses and run your winners - can also be tax-advantageous.

  

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

Your age and overall financial position do enable you to take a slightly higher-risk approach than most. You say that you are potentially over-exposed to the construction and property sector, but I would say it's not something that requires you to make immediate changes.

The three property-related stocks account for about 13 per cent of your portfolio - not a big portion by any means. However, given that your professional background is in the property sector, which is highly cyclical, I would advise not adding more to it. While we believe in the longer-term health of this sector, you have to remember that these stocks have had a good run-up over the last few years and there are some expectations that the performance of the last few years cannot be kept up.

My guess is that the big blue-chip shares with solid dividends bought by your father are the ones that have performed well over the years and now constitute the largest part of your portfolio. These shares highlight the benefits of a longer-term buy-and-hold strategy.

A few months is far too short a time period over which to assess your portfolio performance, especially as you probably have at least another 30 years before you retire. Instead, you should be viewing this period as an opportunity.

  

Russ Mould, investment director at AJ Bell, says:

Given your long-term time horizon and high attitude to risk, coupled with an objective to try and grow the portfolio by 10 per cent a year, you are right to focus on stock market investments rather than bonds and property. That said, some diversification could still reap rewards and reduce risk.

It is also important that you and your wife maximise your tax-efficient allowances. Moving your portfolio into your wife's Isa over time is sensible, and you could also use your Sipp as a tax-efficient place for your investments to grow if you don't need immediate access to them.

Either way, you will need to sell your investments and repurchase them within the tax wrapper. This will potentially result in a capital gain when you sell the investments, but as you have an annual allowance of £11,100, if you ensure any gain made in one year is less than that, there should not be a tax bill to pay.

Reinvesting dividends is also a good strategy so that you can harness the power of compounding over time.

   

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You ask as to whether some funds could improve your portfolio, and the answer is yes. You say you want to diversify away from property and some overseas funds would help you do this. If or when there's a slump in UK property, sterling is very likely to fall, but holding foreign currency would protect you from this. A simple US dollar exchange traded fund (ETF) would be a good hedge, although it comes at the cost of zero or negative returns in ordinary times. Overseas equities would give you higher returns in normal times, but there's also a danger that these would fall if a slump in the UK property market is part of a global downturn.

You also ask whether you should stay in equities, given that returns are volatile and unpredictable. You should certainly have a bias towards them. This is simply because volatility and unpredictability cause many people to avoid shares, with the result that they offer decent average long-term returns for the investor willing to take risk.

What's more, there are two ways to mitigate this risk. One is to observe the 10-month average rule: avoid equities if prices are below their 10- month or 200-day average. Doing this gets you out of protracted bear markets. The other is to recognise that returns are on average seasonal - they are better in winter than in summer. One virtue of funds is that they allow you to vary your equity exposure according to these rules quite cheaply.

   

Helal Miah says:

While you say that you are not ready to put more money in now, regular monthly investing would be a great way to build up your portfolio over the long term. This will allow you to buy more shares when the market falls and less when it is high, achieving good average entry prices over the long term.

If you are disheartened by your stock picking, then I would give a second thought to investing in funds - despite your objection to fees. A mixture of funds and stocks would be ideal to enhance your portfolio. You can establish a core portfolio and diversification through funds while doing your own stock picking for a more fun element. If you feel that fund manager fees are an issue, then you could always consider index trackers which have much lower fees.

I definitely feel that your portfolio would be enhanced if it was more diverse. Your big blue-chip defensive stocks have performed well, but individually they account for too large a proportion of your overall equity portfolio. British American Tobacco, for example, is around 15 per cent of the portfolio and with this industry increasingly under pressure any sudden regulatory changes will hit its share price and your portfolio will suffer an unnecessarily large hit.

Consider cutting down your exposure to some of your larger stock investments and spread out the portfolio better across other share investments.

   

Russ Mould says:

The portfolio is very focused on individual stocks so this is where I'd suggest an element of diversification. You are right to be wary of costs, so it is important to pick a good fund manager with a track record of delivering returns commensurate to those costs. A fund such as Schroders MM Diversity Income (GB00B418R656) could help on the diversification front, as it invests across bonds, stocks and cash - as well as alternative areas.

There are also other collective investments such as investment trusts and ETFs that can minimise portfolio costs.

If you would prefer to maintain full exposure to equities you could consider diversifying the portfolio geographically. With a nod to your desire to minimise costs you could consider Brunner Investment Trust (BUT). It splits money between UK-based and overseas investments, has a yield of about 3 per cent, is currently trading at a discount to net asset value of around 18 per cent, and has an ongoing charge of 0.75 per cent, which compares favourably to other global equity funds.

Another option is an ETF that seeks to track the performance of a broad basket of stocks. iShares Core MSCI World ETF (SWDA) invests across more than 1,600 global companies providing breadth and potential capital upside, for an annual ongoing charge of just 0.2 per cent.