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23-year-old has "talent for equity research"

Our experts say this beginner investor is overconfident about his abilities and give him some tips on how to be more realistic.

Mark is 23 and has been investing for six months. He wants to secure a secondary income, but is also looking to get a job in investments or trading.

He says: "Risk is an unfortunate part of investment. I tend to invest in larger companies and do extensive research before investing due to my inexperience. I have a fairly diversified portfolio, covering industries I've either worked in or studied during my time in academia. I think I have a talent for equity research."

Reader Portfolio
Mark 23
Description

Direct shares and investment trusts

Objectives

Secondary income

 

MARK'S PORTFOLIO

Name of share or fundNumber of shares/units heldPriceValue%
 BP (BP.) 100477.5p£47717
 Royal Dutch Shell (RDSB) 172128.27p£36113
 Centrica (CNA) 122261.43p£31812
 Barrick Gold Corp (ABX:NYSE) 5212.65 USD (£8.34)*£43316
 GlaxoSmithKline (GSK) 211589.5p£33312
 Man Group (EMG) 220206.8p£45416
 BlackRock World Mining Trust (BRWM) 130300.6p£39014
TOTAL £2,766100

Source: Investors Chronicle. *1 US dollar = 0.66 pound sterling

 

LAST THREE TRADES

BP (buy), Royal Dutch Shell (buy) and Barrick Gold (buy).

WATCHLIST

LVMH Moet Hennesey (FR:LVMH) Tesco (TSCO), Heineken (NL:HEIO) AstraZeneca (AZN).

 

DON'T BE OVER-CONFIDENT

Chris Dillow, the Investors Chronicle's economist, says:

You think you have a talent for equity research. I find this implausible, simply because the ratio of 'noise to signal' in portfolio returns is so high that you are unlikely to have any reliable evidence of your stockpicking ability even after six years, let alone six months.

Think about the advantages that the typical fund manager has over you. He has years more experience, is doing the job full-time, has a big and clever research team, and has better access to company management. What offsetting advantages do you have?

This matters because equity research is not like sport or music. In those, an average level of talent is worth having. In equity research, though, it isn't. Average ability should give you average returns. But you can achieve those simply by investing in tracker funds.

There are far more people who are overconfident about their abilities than there are those who can reliably beat the market. Base probabilities thus suggest you are in the former camp. Do you really have good evidence to believe otherwise?

All this might seem negative. But I say it for a reason. You will, at some time, suffer a period of poor performance: even the best investors do. There's a danger that you'll react to these losses by inferring that you can't pick stocks and so give up investing. If you do this, you'll lose the massive advantage you have by virtue of being young - time.

This is an asset in two ways. First, because of the power of compounding. To see this, imagine someone investing £1,000 a year for 25 years, getting a real return of 5 per cent - a reasonable expectation for equity returns. He'll end up with £47,727. If, however, he invests for 30 years he'll have £66,439. That's £18,712 more for an additional investment of £5,000 - a return of 270 per cent. Starting investing early, therefore, is the best thing you can do - but only if you stick with it.

Secondly, being young gives you the chance to learn from the mistakes of old farts like me, as well as from your own mistakes. I'd urge you to read up about cognitive biases: James Montier's Little Book of Behavioural Investing is good, and Dan Ariely and Daniel Kahneman have good books on the more general aspects of such biases.

At worst, these should help protect you against your own potential mistakes (such as overconfidence?).

At best, they might even help you spot others' mistakes and so profit from them. This matters, because I doubt that you can beat the professionals by being a better reader of company accounts than them. If we are to beat them, we'll do so by taking advantage of their weaknesses. This means taking risks that they don't want to - for example liquidity risk or benchmark risk - or by looking for shares that are out of favour because of investors' cognitive biases.

 

Julian Chester, partner and private client broker at Killik & Co, says:

At 23, you have a significant investment time horizon and therefore I would be focusing more on capital growth than generating a secondary income. The prospective yield on the portfolio is circa 4.9 per cent. If you are able to reinvest the income generated this will allow compounding to work its magic over the decades ahead of you.

Overall, it is impossible to time markets to perfection. We naturally become fearful when markets are falling and less inclined to invest, which will assist with stemming the losses in the short term, but will not be beneficial when markets rebound. Some clients choose to invest on a regular monthly basis, which helps to reduce the market timing risk and gives them the benefit of pound cost averaging. This is a quick way to build a diversified portfolio.

 

Ben Yearsley, head of investment research at Charles Stanley Direct, says:

You would like to create a secondary income from your share trading, but you might need to wait until you have built up a larger portfolio first - don't forget that a large proportion of your total return is generated from reinvesting the income, therefore taking those dividends now hampers your ability to grow the portfolio. At this stage, you could also take capital profits as income as well as the natural yield from your portfolio, as the tax-free capital gains tax allowance this year is £11,100. The yield on equities is about 3.5 per cent, so a £10,000 portfolio would give £350 each year - and your portfolio is worth much less than this.

 

HOW TO IMPROVE THE PORTFOLIO

Mr Dillow says:

First, make regular monthly contributions to a general equity tracker fund. Do this via an Isa and/or pension to take advantage of their tax allowances. Stick with this, to exploit the power of compounding. Your 50-something self will love you for it.

Secondly, have a small basket of stock picks alongside this. In forming this basket, keep in mind two principles. One is that you must maximise learning opportunities: keep a record of your reasons for buying, and check whether these reasons were good and, if they weren't, ask what went wrong. The other is that your buys must be based on a good answer to the question: why are the professionals underpricing this stock? The answer will not be because they've missed something about the accounts or about the economy. Instead, it'll be because of something else.

And herein lies something nice. Three of your stock picks - GlaxoSmithKline (GSK), Royal Dutch Shell (RDSB) and Centrica (CNA) - might satisfy this question. They are defensive stocks, and historically defensives have been underpriced (on average) because they carry benchmark risk: fund managers avoid them for fear that they will underperform a rising market.

If you are to succeed as a stockpicker - and remember that the odds are against you - it will be because of things like this.

 

Mr Chester says:

I would focus on diversification. Stock selection is naturally an important part of investing, but diversification across individual investments, industrial sectors and geographic regions is even more important. Your portfolio is UK-focused, it only has seven investments and only has exposure to half of the main industrial sectors.

I am concerned that 59 per cent of the portfolio is focused on the oil & gas and basic materials sectors. I'm happy to have exposure to these two sectors, but such a heavy weighting leaves you exposed to the negative effects of prolonged oil price weakness and a continued oversupply of commodities globally.

I suggest building in exposure to the missing sectors: consumer goods, consumer services, industrials, technology and telecoms. Your watchlist does include three consumer goods stocks: LVMH Moet Hennesey (FR: LVMH), Tesco (TSCO) and Heineken (NL: HEIO). With investing, it is important not to have tunnel vision and not to just stick to sectors you know about, but look at sectors that are well positioned to benefit from the prevailing economic conditions.

You can achieve a higher level of diversification by introducing collective investment schemes. For purist investors, using unit trusts, investment trusts and exchange traded funds (ETFs) is often frowned upon due to the perceived high charges of fund managers, excessive diversification within a fund and managers hugging their benchmarks. I'm a fan of hybrid portfolios which are made up of both direct and indirect investments.

I would encourage you to invest in a European fund such as FP Argonaut European Income (GB00B7K73D30) to benefit from a weaker euro and attractive valuations. This fund provides good exposure to financials, healthcare and consumer goods. Overall, funds can produce significant returns with far less risk than individual stocks. They also open the door to specialised areas of investing that cannot easily be replicated.