Many experienced investors struggle to pass on their wisdom to loved ones who don't take such an interest in growing their money. But this is not necessary as your nearest and dearest don’t need to pick through company reports to grow their wealth. Rather, the key thing is just to get started – get them invested so that they can ride on the magic carpet of compounding.
Renowned US investor Warren Buffett provides a great example. He doesn’t try to teach his wife everything he knows but rather arranges for trustees to put 90 per cent of her inheritance into an S&P 500 tracker fund and 10 per cent in short-dated government bonds.
These underlying principles apply even more when it comes to getting young people to use their individual savings accounts (Isas). Not being knowledgeable on or interested in investing is no handicap as the more you take emotion out of investing, the better. If a novice, or indeed any investor, has a rules-based system and a strategic asset allocation – the proportions assigned to broad categories such as shares, bonds and other assets – they can just let compounding and reinvestment do the rest of the work for them.
Experts such as Greg Davies, head of behavioural finance at Oxford Risk, strongly recommend writing rules and objectives down, and reviewing them periodically. That’s a great first lesson for beginner portfolios and it doesn’t require any more sophistication to start one. As long as you’re invested, you have a chance of beating inflation rather than having the value of cash savings eroded.
Next, you need to decide on a strategic asset allocation. As children and young people have a long time ahead of them, they could have quite a high proportion of their money invested in equities alongside some alternative assets such as real estate, gold, private equity and bonds. Long-term investors could, for example, have about 70 per cent in equities, 15 per cent in alternatives and 15 per cent in bonds.
However, such an asset allocation is high risk and during a very bad sell-off the peak-to-trough fall of such a portfolio’s value would be large – it could half in value in a 2008-2009 type situation. But if you don't need the money right away you could stay invested and ride out these down periods. In this respect, not taking a very hands-on approach to investing is a good thing if it means that you hardly notice when your investments are down.
But if an emotionally important objective, such as having money for a deposit to buy a home, is likely in the near future it is advisable to have a more conservative asset allocation. This would include easily accessible cash.
Crucially, all these choices must come after a sensible life and portfolio review. For example, careful consideration should be made on when to buy a house and how to adjust an investment portfolio ahead of doing it. For example, it would be a mistake to just sell out of everything – actions should be based on how much is needed and when.
For a longer-term asset allocation, investments can be simple and low cost. For equity exposure, a cheap exchange traded fund (ETF) which tracks global equities is a straightforward core holding and what Davies calls “brute force diversification” at its simplest.
If a young or novice investor becomes more interested in investing, they could add ‘satellite’ holdings – smaller allocations to funds focused on specific regions or themes. But they should keep to an overall 70 per cent equities weighting and be strict about how much is in the core holding.
They should also set rules about how many satellite holdings they have in total and what their minimum size is. In a sizeable portfolio worth say, £50,000 (such as those in this week’s portfolio clinic ), many holdings with a size of about £250 to £500 won’t have much effect on the portfolio’s overall performance. But, in aggregate, they will significantly drive up costs.
For bonds – fixed income – choose a couple of funds and keep investing so that they retain their weight in the asset allocation. At least half of the fixed income allocation should be in a lower risk sovereign bond fund, and the rest in a strategic bond fund that invests in corporate and government securities, and targets a low to moderate level of risk.
One third of the alternative asset allocation could be in a gold exchange traded commodity, one third in a global real estate ETF or real estate investment trust, and the other third in a private equity investment trust.
This structure creates a portfolio which is simple to maintain. A novice investor could set up regular investments into it and then check on it every three to six months to ensure that the weightings are in line with the allocation set out above.
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