Investing to pay off my mortgage

Ann Davies' Portfolio

Source: Investors Chronicle. Price and value as at 8 March 2013

LAST THREE TRADES

Shanta Gold - I bought high, but hope for growth in the next year.

Communisis - tipped by IC, I bought a few days too late.

Sold BP one day before hostage crisis - had intuitive feeling they would have another blip, before rising again. Have kept one-third of my BP shares.

WATCHLIST

I am waiting for a good tip, but only have £1,500 to invest.

Chris Dillow, Investors Chronicle's economist, says:

You say that you vacillate between high-risk stocks and safer ones, and your portfolio shows this, being a mix of speculative resources stocks and defensives such as BP, GlaxoSmithKline and Vodafone.

In terms of diversification, this is more intelligent than generally supposed. This is because speculative stocks tend to have low correlations with defensive stocks such as Vodafone and with each other - because the chances of, say, Shanta Gold striking it rich in Tanzania are unrelated to the chances of Victoria doing well in Siberia. For example, looking at the last five years of monthly returns, Beowulf is negatively correlated with Glaxo and has correlations of less than 0.2 with Rambler and EMED. This means there's a good chance that if Beowulf does badly, other stocks you hold will do well, and vice versa.

In this sense, although your portfolio contains some volatile stocks, it is not, in itself hugely volatile.

As for its expected, returns, I'm in two minds. On the one hand, it could benefit in the short term if investors' sentiment lifts speculative stocks. Such sentiment is low now - as measured by the ratio of Aim stocks to the FTSE 100 - and so it could recover, especially if a pick-up in the world economy encourages more risk taking. However, any gains you make from this would be mitigated by poorer performance on your defensives, as these tend to suffer when sentiment improves - but, hey, that's diversification.

On the other hand, remember that correlations cut both ways; spreading risk means you reduce upside as well as downside. I would regard your speculative miners in much the same way as venture capitalists think of their investments; some will fail, a few will break-even and if you're lucky one or two big winners will pay for the others.

Instead, I have two issues here. First, you say this portfolio is intended to cover a mortgage. I fear, though, that while it is not as volatile as some people might think, it is not stable enough to cover it properly; this is because while correlations add almost nothing to the portfolio's volatility, the variance of individual stocks in it is still quite high. To properly match your mortgage, you need a safer portfolio, such as of bonds or at least defensive equities.

While there's a good chance of returns on this portfolio exceeding mortgage rates on average, you cannot rely upon it doing so from month to month or even year to year. If I were you, I would use savings to pay the mortgage, and regard this as a standalone equity portfolio.

But I've a bigger gripe. You say that you've bought some shares at a high price and "will sell when I get to purchase price". This is an error. In economists' jargon it's the disposition effect, or get-even-itis. It's a mistake because, say, Beowulf does not remember the price you bought it at and doesn't care. That price has nothing to do with the share's likely future performance. Holding onto a bad investment in the hope of it reaching some irrelevant price is just silly. The only reason to hang onto a stock is that there's a reasonable chance of it rising. Many things determine this chance - but the price you bought at is not one of them. Forget it. Heed instead, the investment advice of Noddy Holder: "Look to the future now".

Graham Spooner, investment research analyst at The Share Centre, says:

You are a rather novice investor as you have only been investing for one and a half years, so your experience is limited. We would expect you to be very much finding your feet and learning from some of the difficulties of investing in the stock market. Currently, you don't appear to have a clear investment strategy and I think this rather mixed approach will add to your difficulty. However, it seems that you are aware of this as you note that longer-term, lower-risk investing would better suit your needs. We would hope as you build on your experience that objective and strategy become more of a focus to your decision-making.

It is good to see you are now taking advantage of investing in an individual savings account (Isa) and hopefully you will continue to build this portfolio over time. Opting to transfer some of the larger blue-chip companies into your Isa is a sensible decision and has the potential to reward over the longer term. The larger blue-chip investments offer a balance to the portfolio and offer attractive yields and the possibility of some steady growth.

Generally, as investors get older they tend to move away from the smaller more volatile companies. While it is fun to take a punt on one or two companies more often than not less experienced investors get their fingers burnt and you currently have more exposure to these companies than I would recommend. Some of these are penny shares which I would prefer you to steer well clear of with your level of experience.

You should be aware that high-risk tips need to be well evaluated and closely monitored. Shorter-term traders who are closely watching the markets for opportunities can be ahead of the game before investors like you have the chance to buy in, often raising the share price and restricting the shorter-term gains.

Timing is one of the most difficult elements of investing and it appears that this has been an issue for you with the higher-risk aspect to your strategy. It is important for investors not to let a short-term play become a long-term hold. An example of this is that you say you plan to sell some of your holdings when they return to your purchase price, which may never happen. Investing in very small exploration companies is incredibly risky and buying into these companies often needs trader mentality which many investors don't have.

If you want to continue investing in such companies you should look at the company's management to see if they have a track record, assess if previous findings have been discovered in the region they are exploring in and look into the geology of the area. The cash position of the company is also key; very few of these six higher risk companies are making a profit and to a certain extent all are dependent on findings. It is important to assess if they have the cash resources for ongoing drilling as there is the potential that they will come to shareholders for more cash in the future.

Investors build experience over time and often learn the hard way. I hope you continue to build your investment pot over the years and learn from both good and not-so-good investment decisions so that you have more investing knowledge, and are therefore in a better position when you are considering investing any of your inherited money in the stock market.