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Lessons from the Portfolio Clinic

What can reader dilemmas tell us about investing?
October 21, 2021
  • Our weekly portfolio analyses often involve common themes
  • We look at the key lessons for investors

If lifestyle magazines have agony aunts, Investors’ Chronicle has the Portfolio Clinic. A weekly feature examining a reader's assets and how close they are to achieving certain stated goals, the Clinic has addressed all manner of portfolio dilemmas from all manner of different investors over the years. Beyond the noise of markets and company updates, it has provided a direct insight into the challenges that crop up most commonly for those looking to build, manage or pass on their assets most effectively.

Every week, the Portfolio Clinic matches readers to specialists willing to offer their suggestions. But if every case is different, some common themes have emerged over time. From stockpickers with decades of experience to the beginner who cannot yet tell their dividends from their buybacks, individuals turning to the Clinic tend to face many of the same problems and risk falling into the same traps. This in part reflects one of the greatest enemies of every investor: their own psychology and behaviour.

It can therefore be worth taking some time to consider the most common problems when it comes to portfolio construction and the associated financial planning. An IC analysis of 41 recent Portfolio Clinic entries, starting with the feature in our end of 2020 issue and ending with the instalment of 8 October 2021, can offer some handy rules of thumb.

 

Avoid too many holdings

By far the most common problem in our sample, specialists diagnosed a case of too many holdings in around a fifth of the entries analysed, with one case proving particularly extreme. Chris Dillow, the magazine's economist who commonly pens one of the two responses to each of our reader submissions, recently came across an individual with 116 holdings, most of which were shares. As he put it in the issue of 8 October: “You own more individual stocks than any retail investor I’ve seen.”

Most cases are much more nuanced than this, but overpopulating a portfolio is still one of the simplest mistakes to make in investing, given it can be easier to add an exciting name to your roster than offload a holding. Equally, investors may be keen to diversify but end up with a portfolio that is hard to manage.

This can certainly be the case with buying shares and some other direct holdings. The diligence required to properly monitor individual companies means that holding a large number will prove difficult, unless the investor has the necessary time and enthusiasm. What’s more, some of the most respected investment tomes argue that including extra companies in a portfolio can have diminished diversification benefits after a certain point. As Burton Malkiel famously argued in his book A Random Walk Down Wall Street, the total risk of a portfolio is reduced by 70 per cent once it contains around 20 “equal-sized and well-diversified issues”. But upping the number of holdings any further tends to do little to reduce risk. It's notable that some of the more successful fund managers of recent years, including Terry Smith and Nick Train, have run notably concentrated portfolios of shares.

Some individuals from our chart did have a substantial number of direct holdings (something that sometimes include bonds but mainly involves shares). The reader whose number of holdings surprised our economist had 105 direct investments. As the chart below shows two other readers held 64 and 41 shares, respectively, at the time of their submissions.

But are shares really the problem? While Investors’ Chronicle caters largely to stockpickers, there is evidence that plenty of readers make good use of funds: 28 of the 41 entries in our sample involved portfolios with a bigger number of funds than stocks. In a number of cases, readers used nothing else.

This tendency seems pretty healthy: given that even concentrated active funds tend to have at least 20 or 30 stocks (and some passives have hundreds or thousands), investing in them provides an instant level of diversification. Funds also allow us to reach some investment universes where direct investing is difficult, while leaving some of the work to investment managers can allow DIY investors with the inclination to focus on a handful of top stock picks.

But different problems can come from loading up on funds. Investors can fairly easily diversify with a small number of funds, potentially using between five and 10. If they use a substantial number of funds they end up with smaller portfolio positions that contribute less to overall returns, and with a spread of underlying exposures that may offset each other. Using lots of funds can mean plenty of investment management fees to pay – including the higher charges levied by active funds. In the worst cases, readers run the risk of creating what Dillow likes to call “an expensive tracker” – inadvertently buying a big chunk of the market while paying hefty active fees. As the chart shows, some readers might consider reducing the number of funds they use. In one entry, a reader held 43 different funds.

While opinions differ, some broad rules of thumb can be useful when trying to keep different forms of portfolio sprawl in check. Some specialists argue that investors could hold somewhere between 30 and 50 individual shares – although the threshold may actually be much lower when considering what you have the time and interest for. When it comes to active funds, some argue you should hold between 10 and 25 different names, although that upper threshold may again seem high. Passive funds, with their much greater breadth, should significantly lower the maximum.

Other rules might be easier to follow, such as having minimum and maximum position sizes. A holding should usually make up at least a few per cent of your portfolio to make any difference to returns, but direct holdings should be limited in how much sway they have. A double-digit position dedicated to a stock may well raise eyebrows. Other observations on the subject can be found in the IC of 19 June 2020 (“How many portfolio holdings should you have?”).

 

…but don’t forget to diversify

Investors do sometimes hold too few investments. But frustratingly it can also be entirely possible to have an unwieldy, overpopulated portfolio that still lacks enough diversification to weather the uncertainties of investing. Usually this means an overreliance on one type of investment. To give one example, while the reader mentioned earlier had 116 holdings in part because of a desire for diversification, their portfolio had a strong bias to the UK, with little exposure to global markets. This preference for the familiarity of domestic markets, while understandable, can mean forgoing impressive returns elsewhere and becoming overly reliant on one market.

Diversification matters when it comes to geographies and sectors, but it also makes sense when considering asset classes. Many readers entering the Portfolio Clinic will have long (and successful) investment track records – but a focus on asset growth has left them exposed to equities and little else. Other assets matter as and when we look to preserve capital.

Unfortunately, finding good diversifiers remains one of the most difficult tasks in investment. Gold and bonds have worked as a buffer against equity market volatility in the past but currently face big question marks, while alternative assets have their own problems. Take the big premiums on infrastructure investment trusts, doubts about the resilience of music royalties as an asset class or the mixed records of absolute returns, to offer just a few examples. Investors who rely on their portfolio may wish to spread assets across different diversifiers, or simply load up on cash that can help them avoid eroding their asset base by making portfolio withdrawals when markets are down.

Recommendations for cash piles tend to range from something that can see you through you six months to a few years’ worth of outgoings. As our second chart shows, cash levels in portfolios can vary enormously and will partly depend on your circumstances, appetite for risk and what helps you sleep at night.

 

“Do we have too much Baillie Gifford?”

Having too much of your money in one kind of investment can take other forms. After more than a decade of particularly strong gains for the likes of tech stocks (and growth investors), there are valid questions about how much should be invested with certain winning stocks or funds.

A prime example of this dilemma is the debate about Baillie Gifford. Several funds run by the asset manager have had enormous success backing growth stories, leading some investors highly dependent on the continued fortune of one fund firm.

Baillie Gifford is just one example: investors also frequently question how heavily they should back managers like Terry Smith. It can be important to remember that style diversification matters: as the cyclical rally of recent history shows, it can be helpful to back a mix of funds (and stocks) with different characteristics. A Baillie Gifford or Fundsmith offering could be paired off, to an extent, with a value fund. An example of both the Baillie Gifford and style dilemma can be found in the Portfolio Clinic of 30 April (“Do we have too much with Baillie Gifford?”).

Likewise, investors may want a mix of different fund structures to weather different scenarios. Investment trusts, in theory, are more susceptible to equity market volatility than their open-ended counterparts, while investors will have their own opinions about where active and passive strategies work best. A good way to capture nuances can often be by having a “core” exposure to markets – via passive funds, broad active funds or a mixture of all – and adding more niche positions at the margins.

 

Portfolio management isn’t always about investing

Investing can be exciting, and some readers are at the very beginning of the process: our sample included one 18-year-old seeking to build up enough money for a house deposit by investing in four different funds, while another entry concerned a parent running portfolios for children aged seven, 11 and 13. In these early days your decisions can be relatively simple, with a focus on maximising growth, likely via equites and other “risk” assets.

Things inevitably get complicated later on, when an investor has successfully built up substantial assets - as many readers have.

A number of the readers were at risk of breaching the pension lifetime allowance. Ways to mitigate this include ceasing pension contributions, deploying new investments into an Isa or taking a tax-free cash sum from a pension, but all are dependent on idiosyncratic circumstances. On the other side of the coin, the many readers looking to pass assets onto their loved ones and minimise an inheritance tax (IHT) bill would do well to run down assets in vehicles such as Isas and preserve pensions, given they fall outside an estate for IHT purposes. Tax considerations become increasingly important as your assets grow, and sometimes turning to a specialist is the best option.

 

Yield, risk and the alternatives

Given that portfolio management grows more complicated before or during retirement, income remains a big subject of discussion for many readers. Portfolio Clinic entries often centre on a target yield or income to be generated each year.

Equities and some alternative assets, such as infrastructure, may appeal as a source of income. But it can be important not to led yield requirements lead your investment decisions too much. For one, having a diversified growth portfolio and taking capital gains can be as valid a source of funds as buying high-yielding stocks that may prove riskier.

Specialists disagree about whether 4 per cent is now a safe withdrawal rate from a portfolio, as some once believed. But there can be other options. Prosaic as it sounds, investors can take action like moderating their expenditure where possible, rather than embracing too much risk at a precarious moment. On a similar note, investors earlier on in their journey should remember that contributing more to the pot can be as effective as finding the very best investments, if not better.

 

Don’t forget what matters

Important as reaching your financial goals can be, a focus on maximising or passing on your assets can sometimes get in the way of life itself. Some readers may defer state pensions well into retirement in the hope of achieving the greatest portfolio value, while some prioritise Sipp growth over their own needs.

Such behaviour can be easy to slip into, but once you are contributing to a diversified portfolio it can be important not to let it adversely affect your everyday life. So went one takeaway from the Portfolio Clinic of 11 June (“How can I build up enough to support early retirement?”), discussing the case of a woman who wanted to build up enough of a portfolio for the possibility she may have to withdraw from work due to ill health.

As Dillow noted at the time, she should also remember to spend on experiences, such as holidays, weekends away and “me time”, in the hope of building up a stock of happy memories for the future. As he added: “Nobody remembers that blissful time they put £20,000 into an Isa!”