Temper your 'skew-whiff' expectations and diversify your portfolio

"One of my 'big hairy audacious goals' is to develop my portfolio so that in eight to 10 years I can generate an income by just investing or re-investing in equities," says Deepak. "My aim is to get a return of at least 12 to 15 per cent a year from my equities portfolio.

"I am a long-term investor, and largely follow the investment approaches of renowned US investor Warren Buffett and fund manager Peter Lynch. I look to invest in securities that I can buy and forget.

"I have learnt to acknowledge my biases and behavioural weaknesses - I had a tendency to follow the trend and not deeply analyse a potential investment's fundamentals. I can tolerate risk and am prepared to lose 15 to 20 per cent in any given year due to my long-term view.

"I recently invested in Amazon (US:AMZN) and Alphabet (US:GOOGL). These are expensive from a fundamental perspective, but in future they will be the biggest databases on earth. As artificial intelligence and the internet of things will dominate the next decade, these companies are well placed to take advantage. And as they are cash-rich they should be able to sail through any adverse financial crisis or recession.

"I have also recently invested in Charles Taylor (CTR), a UK-based company that provides services to the insurance market, and has a robust balance sheet and non-capital-intensive business model. But I bought it because [at the time] it had a yield of 4.95 per cent and I thought it was cheap on a price/earnings ratio (PE) of 14.5.

"I am now considering investing in toy maker Character (CCT), which looks cheap in view of its good financial health and performance. I also want to diversify my portfolio with some smaller companies.

"As well as my portfolio, I own my home and have four bank accounts that pay interest rates of between 1.5 per cent and 5 per cent. I also have a portfolio of Indian equities worth around £5,000 and a commercial property in that country valued at around £20,000. And I have a workplace pension into which my employer makes contributions."

Deepak's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You have two chances of getting a 12 to 15 per cent annual return from this portfolio: slim or none.

This isn't because you've invested badly, but because we now live in a world of secular stagnation, in which overall returns will be moderate. To see what I mean, think about what long-run returns we should expect from equities.

One way to do this is to add a risk premium to bond returns. With bond returns negative in real terms, only 2 to 3 per cent real returns are likely from equities. This splits the difference between the historic equity premium since the 19th century and that which theory predicts.

Another way would be to assume that shares are fairly priced so the dividend yield won't change from now on, so with the S&P 500's cyclically-adjusted PE above average this assumption might be generous. This implies share prices will grow at the same rate as dividends. Then if we assume no sustained change in the share of profits in national income, or in the proportion of profits paid to investors, dividends will grow at the same rate as gross domestic product (GDP), which should be around 2 per cent a year. This would give total real returns of around 5.5 per cent a year: 2 per cent growth and 3.5 per cent yield - although dividends in the US are lower and share buybacks higher, this doesn't change the maths. This suggests that you can't achieve your target by market returns alone.

So I don't think your 'big hairy audacious goal' is appropriate. Insofar as these goals work, which is doubtful, it is because they inspire people to strive harder and better [these are strategic statements that aim to focus a business on a single medium- to long-term goal]. But this only works if the goal is within their control. Equity returns, however, are to a large extent beyond our control: for example, if the market slumps even the best investors lose.

Ian Forrest, investment research analyst at The Share Centre, says:

In terms of your overall strategy I'd say that seeking to follow in Warren Buffett's footsteps is a good aim, and you are certainly right to have a long-term investment horizon. However it's worth noting that Mr Buffett's success came over an even longer period - 15 to 20 years - rather than the eight to 10-year target you have set for yourself.

I like the idea of applying a 'big hairy audacious goal', a common concept in business strategy, to investing. But you are less likely to achieve it if you 'buy and forget' your investments. Investors should always check regularly on their holdings - at least every six months.

You have done exceptionally well so far - 18 per cent capital growth in two-and-a-half years is impressive. But it will be a challenge to maintain this level of momentum: to attempt to achieve a 12 to 15 per cent a year return you will have to take on some risk, although reinvesting dividends will help.

James Norrington, specialist writer at Investors Chronicle, says:

Assuming your target return of 12 to 15 per cent is nominal, then you're probably needing to make double the long-term real premium for global equities. Over your stated timeframe of eight to 10 years this is a tall order, and will require skill and a tremendous amount of luck.

Great investors such as Warren Buffett and Peter Lynch can outperform the market over the long term, despite assertions of the efficient market hypothesis to the contrary. It is worth stressing, however, that these legendary investors had a long-term outlook and also benefited from some good periods for equities. This is not to do down their mightily impressive outperformance - exceptional decision-making in bear markets is also a hallmark of Mr Buffett. Rather, it is worth emphasising that you are starting out in a new and challenging era, and should consider the possibility that the next decade may be one of the weaker spells for equity performance.

You couldn't have picked two better stockpicking gurus to follow, so there is little to add to what these great investors have told you in their books. You work in cyber security so your penchant for tech stocks does chime with Peter Lynch's mantra that you should "invest in what you know".

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio looks very good. It's weighted towards the sort of defensive stocks that outperform on average over time. Most of your holdings seem to meet Buffett's criterion of having 'moats' - attributes such as high capital requirements, strong brands or an entrenched market position that allow companies to fight off competition.

And I think you're wise to regard Alphabet (Google) and Amazon as better placed than small speculative stocks to take advantage of future technical change: their cash piles and technical know-how enable them to act as venture capitalists, buying up potentially good small firms.

Nevertheless, I'd not expect this portfolio to beat the market by the near-10 per cent a year you need for a 15 per cent return. I find it implausible that the premia to good stocks are that big.

What's more, I'd question whether any basket of stocks is truly a "buy and forget" portfolio for the long term. History warns us that over the long run even the biggest and best companies can go into decline, and we cannot predict the pace and direction of technical change, and the creative destruction it brings.

For this reason, you're right to back the field rather than individual horses by holding a global tracker fund - Mr Buffett would endorse that.

Even this, though, takes a particular, and to my mind risky, bet: that future corporate growth will come from quoted stocks. I'm not sure it will. So consider investing in some private equity investment trusts as these might offer exposure to some growth that listed stocks don't.

Other than that, this is a decent portfolio. It's your expectations that are skew-whiff rather than your investing.

Ian Forrest says:

This is a well-diversified portfolio, although having 18 holdings in a portfolio where the equity investments only add up to about £11,000 raises the risk of relatively high charges eating into returns.

It is interesting that you have recently added Amazon and Alphabet to the portfolio. These often feature in investors' lists of the companies they wish they'd bought sooner, yet you feel there is still plenty of growth potential in these stocks. You could be right, and with your background in tech you arguably come from a more informed position than the average private investor. However, large cash holdings are no guarantee of future success - the market will want to see Amazon and Alphabet reinvest those funds in the business for future growth, or return them to shareholders.

To achieve the kind of capital growth you are aiming towards you could consider reducing your holdings in GlaxoSmithKline (GSK) and Lloyds (LLOY), and increasing your exposure to emerging markets. As an experienced investor in India you could consider adding this region to your UK portfolio. Jupiter India (GB00B4TZHH95) is one of our preferred funds.

Character Group is a smaller company listed on the Alternative Investment Market (Aim), so is certainly a higher-risk idea, and you should bear in mind the company recently reported that sterling weakness has hit profitability.

James Norrington says:

It irks some readers when we give out what comes across as life advice in this column. Their criticism is often that they don't need to be lectured on risk: they have already decided to invest and just want some pointers on the securities that could best help them achieve their objectives.

The problem is that human beings are naturally bad at assessing probabilities - our brains have a natural optimism bias, which leads us to assign too low a probability to risks in decision processes, even if we understand that statistically there is a higher chance adverse outcomes will materialise.

So how risky is your portfolio really? You say you are comfortable with a 15 to 20 per cent drop in its value in one year. But an equities portfolio like yours could potentially lose this much in just a couple of months if there is a dramatic event that sparks a sell-off, like the one in the autumn of 2008 when Lehman Brothers collapsed.

During this financial crisis the MSCI World Index of global blue-chip equities fell 54 per cent. Your iShares Core MSCI World UCITS ETF (SWDA), a very sensible core holding, tracks this index, so its fall in value during the last major downturn should give you an idea of the risks of investing in shares.

Your investment portfolio is very concentrated and only has investments focused on equities - you have no allocation to other asset classes to diversify risk. As you have such an ambitious growth target, a level of concentration is inevitable, but this means taking on the risk of a big fall in equity markets that would lengthen the time it takes to achieve your goals.

Finally, pay attention to the number of holdings you have. Your portfolio is not unwieldy, but it could become unwieldy if you keep adding small holdings in new stocks. Try to keep your number of holdings roughly similar - it may be worthwhile deciding on a minimum size of holding and sticking to it.