One of the key rules of investing is that you need to diversify your assets to spread risk and potentially increase prospective returns. The fewer assets you own, the more chance there is that th
One of the key rules of investing is that you need to diversify your assets to spread risk and potentially increase prospective returns. The fewer assets you own, the more chance there is that the capital value will drop if a particular company, sector or country goes through hard times. Another key rule is to set up an investment strategy based on your specific objectives, circumstances and time horizon. You then keep focused on your strategy and, depending on the assets, aim to hold them for the longer term.
Recent studies have however shown that many investors leave themselves overexposed to risk and give in to the temptation to frequently buy and sell assets. Both could prove costly mistakes.
New research published by global asset management firm Schroders in June revealed that too many equity investors are reliant on just one company?s fortunes.
1.5 million people own shares of a single company as their equity investment, and another 1 million have over 90% of their direct share holdings in one company.
Schroders describes this (and I thoroughly agree) as ?a notoriously high risk strategy?.
Managing Director of its UK Intermediary Business, Robin Stoakley, commented:
?Investing in a single company does leave one potentially exposed should that business run into difficulties. In the last few years we have seen established businesses rapidly disintegrate, such as Bradford & Bingley and Northern Rock, leaving little or no value for investors.?
Another good example to use here is BP. Who could have forecast the Gulf of Mexico oil spill and the effect it had on its share price? It has since improved, but there were worrying times for investors reliant on its share price.
Indeed, almost a third of the investors surveyed by Schroders said they were waiting for their share price to improve before selling to avoid making a loss. While this is understandable ? and indeed usually recommended ? it does leave them in a very risky position? one they are possibly in because they didn?t have adequate diversification in the first place.
Around 5% of investors gave sentimental reasons for not wanting to sell their shares, for example they are shares of the company they word for/used to work for, or they were a gift. Another 5% plan to give them to family in the future.
While you can never completely eliminate risk, you can manage it and diversification is a key tool to achieving this. As Stoakley said in the Schroders press release, ?A balanced investment portfolio sees investors spread their risk, while potentially generating strong returns.?
Investing in equity funds, rather than just buying individual company shares, is the simplest and quickest way of diversifying your equity holdings across companies, sectors, capitalisations and countries.
Another new study shows the potential dangers of letting emotions control your investment decisions. This brings me back to the theme I have discussed many times before ? it?s time, not timing, that reaps the most results.
A study by Barclays Wealth called Risk and Rules: The Role of Control in Financial Decision Making surveyed 2,000 high net worth individual investors earlier this year.
It found that investors who make investment decisions based on emotion rather than strategy lose on average up to 20% of their potential returns over a 10 year period.
Many of the investors said they felt compelled to trade frequently, even though they realised they are trading too much.
The problem with buying and selling, rather than buying and holding, is that it is all too easy to make your decisions based on the wrong reasons. If markets have a bad week you get cold feet and sell ? which will lock in your losses. Or you decide to buy because markets have been rising for a while and you want to share in the gains ? but you may have missed a lot of the rise and risk having bought at the top of the market. Basically, those who let emotion rule their head too often trade at the wrong time. In any case, it is virtually impossible to consistently get market timing right ? there are too many events which cannot be predicted.
The Barclays Wealth study also found that people who employ an investment strategy tend to feel more satisfied with their financial situation and the group with the highest strategy usage is 12% wealthier than the group with the lowest strategy usage.
Other studies have shown that investors who buy and hold get better results than those who buy and sell frequently. I?ve mentioned the Dalbar study before, but it?s worth mentioning again. It looks at US investors and markets and found that in the 20 years to 31st December 2010 the annualised return of the S&P 500 index was 9.1%… but the average equity fund investor only received annualised returns of 3.8%.
This is largely because investors react to market movement and news and buy high and sell low repeatedly. Fund investors who hold on to their investments are more successful than those who time the market.
While I do advocate the use of a buy and hold strategy for many investors, it is essential that in the first place your portfolio is based on your specific aims, situation, risk tolerance and time horizon. Also, buy and hold does not mean buy and ignore completely. You do need to review your portfolio at least once a year to see if it needs to be re-balanced or if your circumstances have changed. An experienced wealth manager like Blevins Franks will review your investments and recommend a tailor made strategy going forward, one which will help you avoid making costly mistakes.
By Bill Blevins, Managing Director, Blevins Franks
17th June 2011