When we look back over the seven and a half years that we’ve been writing articles on the do’s and don’ts of investing, certain subjects are bound to repeat themselves.

So we thought we’d take a look back and highlight some of the most important topics:

Overview

• Why are you investing?
• What timescales do you have for your various goals?
• Only invest in what you can understand and keep it simple
• Don’t listen to the noise of picking hot stocks
• Buy & hold
• Rebalance your portfolio regularly
• Have an Investment Philosophy, not a collection of policies

Risk & Return Are Related

• What risks are you willing or not willing to take?
• What risk do you need to take to achieve your goals?
• When markets are volatile how do you react?
• What are the likely potential gains and losses on your portfolio?

Performance

• Academic research conclusively shows that active funds do not, after costs and over time, beat index funds
• Past performance is not a guide to future performance
• Beware of following the herd
• Emotions, such as fear and greed, can get in the way of a successful outcome

On these last two points, in a previous article we quoted Erik Davidson, Managing Director of investments for Wells Fargo Private Bank who said:

“In all other areas of life, we want to buy more if prices go down. With investments, people buy when prices go up.”

Trying To Time the Market

Again, in a previous post we used figures from Dimensional Fund Advisers who showed that in being out of the market, the risk is that the investor will miss the big rises that really boost performance.

As an example of how important this is, if you take the years January 1986 to December 2010, here are the annualised rates of return based on missing certain periods:

Totally invested – 10.18%

Missed best 5 days – 8.54%

Missed best 15 days – 6.46%

Missed best 25 days – 4.75%

Costs

Whereas we haven’t a clue as to future performance, what we do know is the costs of the portfolio, which act as a drag on performance.

Therefore:

• Buy funds at the wholesale (institutional) price, not retail
• What about legal and administration costs?
• What about trading costs when the manager buys and sells?
• What does my adviser charge me up front and ongoing?
• Annual management charges?

Tax

• What are the implications with HMRC?

Accessibilty

• How easy is it to get at your money if you need to?

Then we come to a subject which confuses some investors…

Diversification

Spreading an investment portfolio across the different asset classes is paramount when creating a truly meaningful balanced portfolio.

The basic asset classes are:

• Cash
• Fixed interest
• Equities
• Property

No one can accurately and certainly not consistently predict which of these asset classes will perform best in a given year.

So this being the case, and each asset class having their own risk & return characteristics, creating a portfolio is all about the proportion of one asset class to the other.

This ‘meld’ is then your asset class portfolio, and off you go.

However, sometimes when we discuss this with a new client, they will say that yes they definitely have diversification as their adviser has put them in lots of Managed Funds!

This is understandable, however it’s a major mistake.

Quite simply what this achieves is not diversification between the asset classes, but a concentration of the same type of equities!

Most Managed Funds are mostly invested in equities, and do not have a significant holding of the other asset classes.

For example, U.S. stock-market researcher Larry Swedroe found that investors mistakenly believe that it’s the number of different mutual funds they own that defines how diversified their investments are.

On the contrary, he shows that owning 10 actively managed funds that all (for example) focus on U.S. large-cap stocks, will commonly give you the same stock market exposure as a single low-cost index fund – all while incurring much higher costs!

These mistakes can really cost an investor, and it brings home the importance of investors educating themselves.

Action Point

It’s really important that all investors see beyond what we would call ‘fancy marketing’. That is, companies who may sell their offering on style rather than substance.

Yes, whilst it’s important to know that the company (whether the company is a fund management company or an adviser firm) you are dealing with is professional, make sure you take the time to dig beneath the surface so that you can do your due diligence.