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A portfolio full of clutter

Jane would like to rationalise her portfolio of 50 holdings, but is not sure how to go about the process

Jane has been investing for four years with a buy-and-hold strategy of at least three years. She also aims for growth via dividend reinvestment. The 50-year-old's attitude to risk is mixed. "The majority are solid stocks but I like a flutter with some smaller value stocks," she says. "I don't mind the occasional loss, but on the other hand I use my individual savings account (Isa) allocation each year.

"I follow the IC tips and I like to build my shareholdings in the stocks I already hold by drip feeding purchases."

Reader Portfolio
Jane 50
Description

Objectives

Growth via dividend reinvestment

"I have a decent pension, so I do it for fun and do not have much of a plan or objective, save that I like to take all my recommendations from the IC (exceptions being National Express and some old shares such as Barclays picked up randomly years ago). Sad to say, I first put my toe in the water in August 2008 and took the inevitable bath. Before that I knew nothing about investment, and I suspect I still don't, although piles of dog-eared Investors Chronicles are testimony to my efforts to rise above the rank amateur.

"I think I have too many stocks and I find that it is increasingly difficult to make the portfolio grow. I would like to rationalise, but am not sure how to go about this process and am finding it hard to take a rational view. I suspect this is because I love all my purchases and believe they will ultimately come good; also, if the holdings are tiny I cannot see any point in selling as the transaction costs would be too onerous."

JANE'S PORTFOLIO

Name of share or fundShares/units heldValue £*
ABCAM615£2,194
ADVANCED MEDICAL SOLUTIONS434£364.56
AMEC102£921.57
ARTEMIS ALPHA TRUST340£985.15
ARTEMIS INCOME I ACC3480£7,773
ARTEMIS SPECIAL SITUATIONS2266£7,492.90
ASIAN CITRUS HOLDINGS702£335.20
ASSETCO200£3.50
BAE SYSTEMS251£721
BALFOUR BEATTY685£1,735
BARCLAYS281£434.56
BRIT EMPIRE SECURITIES & GENERAL IT241£1086.91
BLACKROCK SMALLER COS IT175£798
BP 556£2,257.90
BRAEMAR SHIPPING200£626
BTG503£1,406
CENTRICA780£2,314
CITY NATURAL RESOURCES HIGH YIELD IT291£828.62
DIGNITY102£870.06
EDINBURGH INVESTMENT TRUST248£1,100.37
EPISTEM HOLDINGS100£375.45
FIDELITY CHINA SPECIAL SITUATIONS IT7200£5,882.40
G4S365£973.45
GLAXOSMITHKLINE187£2,485.23
HANSARD GLOBAL294£482.16
HERALD IT182£814.45
HUTCHISON CHINA MEDITECH217£672.70
IMPAX ENVIRONMENTAL MKTS IT796£768.14
INTERNATIONAL POWER649£2,145.59
JUPITER EUROPEAN OPPORTUNITIES IT355£828.92
MAN359£830.72
MERCANTILE INVESTMENT TRUST100£911
MERCHANTS INVESTMENT TRUST383£1,401.78
MURRAY INCOME TRUST173£1,025.02
NATIONAL EXPRESS333£788.21
NATIONAL GRID368£2,379.12
PERSIMMON100£470.90
PRUDENTIAL280£1,668.80
ROLLS-ROYCE HOLDING191£1,194.70
SCOTTISH AND SOUTHERN ENERGY111£1,460.76
SCOTTISH MORTGAGE IT163£1,089.65
SCOTTISH ORIENTAL SMALLER COS IT172£1,025.12
STANDARD LIFE UK SMALLER COS IT461£948.50
TEMPLETON EMERGING MKTS IT202£1,123.12
TISSUE REGENIX GROUP1145£145.98
VODAFONE721£1,175.23
WEIR GROUP155£2,763.65
WITAN PACIFIC IT478£884.30
WORLDWIDE HEALTHCARE TRUST140£975.10

*Value as at 21 September 2011. Jane also has a large holding in an RBS inflation bond.

Chris Dillow, Investors Chronicle's economist, says:

This looks like a well-diversified portfolio. You have some exposure to emerging markets and a speculative holding, leavened by some defensive utilities. Granted, your exposure to financials and more adventurous commodity stocks is small, but this is quite reasonable, especially as the latter are reasonably correlated with emerging markets.

My problem is that it is too diversified. Of your 50 holdings, 36 comprise less than 2 per cent each of your portfolio. Such small holdings have three drawbacks.

One is high dealing costs. If you hold £1,000 of stock for a year, you can easily pay £25 or more for the privilege; £5 stamp duty, plus £10 each when you buy and sell. This is 2.5 per cent of your holding, which could easily represent a third of annual returns in an average year.

Because dealing costs, other than stamp duty, are usually a flat fee, fewer and larger holdings would economise on such costs.

Secondly, if a stock comprises less than 2 per cent of your portfolio then even if it rises 50 per cent, it will add less than a percentage point to your overall performance - which is about one day's ordinary variation in its worth. And because it is vanishingly unlikely that a significant fraction of these 36 holdings will (net) do so well, it follows that your portfolio is likely to perform more or less as the stock market generally does.

This is especially true because several of your significant holdings are of funds which - because they too are diversified - are unlikely to deviate very much from the market’s performance. You have a near-tracker fund, without a tracker fund's low costs.

The third drawback here is the old law of diminishing returns. Let's concede that the equity market is inefficient, so that there are some genuinely underpriced stocks to be bought. How many of these are there? And what are your chances of finding them?

Few and slim. Work by the London School of Economics' Christopher Polk has found that the average fund manager can spot around half a dozen outperformers, but he dilutes their good returns by also holding lots of mediocrities.

Fund managers have an excuse for doing this; if you're running a £100m portfolio, liquidity risk prevents you holding just a few shares. But retail investors, with our smaller portfolios, don't have this excuse.

And yet it is very common for investors to overdiversify. We are quicker to see buys than sells - perhaps because buying is pleasant - there's novelty value plus the hope of gain - while selling is less so, especially if it means we have to acknowledge our error in buying in the first place. The upshot of this is that we accumulate shares over time, with the result that our portfolios look like our garages - full of clutter that we once had a reason to buy but which now just gets in the way.

Richard J Hunter, head of equities at Hargreaves Lansdown Stockbrokers, says:

You have a broad selection of shares and funds - almost evenly split - and a variable attitude to risk.

As with so many investors, you have gained appreciation of the importance of the dividend payment. The dividend has historically formed an important part of an investor's return. The compound effect of reinvesting dividend payments over the long term is very positive for portfolios.

Your tendency towards higher-yielding investments leads, in the words of Einstein, to the "eighth wonder of the world" - namely compound interest, and therefore the importance of reinvesting dividend income into the stock. The longer you hold, the more powerful this becomes. The 2011 Barclays Capital Equity Gilt Study quoted the example of £100 invested into UK equities in 1899. Without reinvesting dividends, the £100 would have grown to (nominal) £12,665 today, or real (inflation built in) £180. By reinvesting the dividends, however, these figures would be a remarkable £1.7m nominal, or £24,133 real today. Given the historically low current interest rate environment, we continue to favour UK equity income funds.

A few of your funds, such as Templeton Emerging Markets (yield 0.75 per cent) and Impax Environmental Markets (yield 0.78 per cent), do not fit the traditional mould of income-generating funds, relying more on capital growth supplemented (hopefully) by income growth. On the shares side, there are a number of classic income-generating investments, within sectors such as pharmaceuticals, utilities and telecoms. Any growth need not, of course, be confined - as was traditionally the case - to the UK, and this might be borne in mind when taking decisions on equities or, in particular, funds.

The practice of pound cost averaging, or drip feeding, funds is one to be encouraged, since it reduces market timing risks. The portfolio itself now stands at around 50 lines of shares and funds, many of which are below £1,000 in value, which is slightly unwieldy. Depending on the amount of time you have to devote to the portfolio, some consolidation might be considered.

Of those stocks on the watch list, a number of the blue-chip companies mentioned are currently well regarded by the market consensus of analysts, including Tesco, BG Group and Standard Chartered.

Moira O'Neill, Investors Chronicle's personal finance editor, says:

You are right to want to cut down on the number of holdings. Many fund managers who invest professionally for a living only hold 20-25 lines of stock and you are holding twice this. It is easier to buy than to sell, but if you carry on like this you could end up with a portfolio of 100 holdings in four years' time.

Try to look at your portfolio without emotion. If you were starting investing today, what would you choose? Keep your top 25 choices and discard the rest.

Alternatively, take a contrarian view. Look at what has risen in value and sell this to buy more shares in holdings that have fallen. You can always come back to your favourites when there is another buying opportunity.

Last tradesTrade actionShares on watchlist
Advanced Medical SolutionsBuyAggreko Batteries
British Empire SecuritiesBuyBabcock International Defence
City Natural ResourcesBuyBG
Cranswick Sausages
Devro Sausage Skins
Greenco
GW Pharma
Halma Health & Safety Products
Hardy Insurance
James Fisher Oil Services
Nichols Vimto
Pennon Water
Provident Financial Loans
PZ Cusson Soap
Ricardo R&D Engineering
Rotork Engineering
Serco Services
Spirax-Sarco Engineering
Standard Chartered
Tesco
United Utilities Water
XP Power Supply