How To Invest Effectively

Contents

I have been in the investment word for some thirty years during which time I have seen a variety of systems and the mistakes people make when investing. I have also made more than my fair share. In this article my aim is to help you avoid the many pitfalls of investing, and help you improve your returns. Note this is not going to deal with stock picking or or spotting the next big money making opportunity.

 

1 Stick to a plan and know your aims

Many people have no real aim when they start investing, other than to make a fortune. To make a small fortune in investment start with a big one. Before you get underway think carefully what it is that you wish to achieve in your own terms. Do not use investment terminology if you do not understand it. Is the money for your old age, saving for something, for fun? Each aim will need a slightly different approach and you will above all need to consider the structure of a portfolio as regards the split of the different investments held.

For example a make as much money and gamble on the latest hot tip portfolio will be substantially different from one oriented to long term saving. Once you have a plan and some guidelines you should stick to it, and if necessary have a separate portfolio if a different aim is appropriate for those funds.

 

2 Review regularly and monitor performance

It is imperative that say once a quarter you review a portfolio and ensure that it is structured in accordance with your objectives, and that the securities held are appropriate. Consider the balance of a portfolio towards low risk bonds and cash, and how much is in more volatile shares. Is the balance appropriate to your investment aims and your views as to what might happen to them?

Sometimes you may wish to add to a position or trim profits. Sometimes you may need to cut out a holding which has not moved as anticipated, or markets may have changed. If an idea has gone wrong re-evaluate it and cut it out if it can no longer be justified. Otherwise you will have too many “long term” holdings cluttering up the portfolio.

If you are running a stock picking portfolio you must monitor performance. When you compare your returns to market averages you will quickly learn if your stock picking skills are any good. If your returns are equal to or less than the average for the market you are best off away from stock picking, and you will save on dealing costs. Once you have 14 holdings in a market you will most likely be getting the average market return.

 

3 Investing through a broker

This is the first stumbling block for many. Simply put if you invest through a traditional stock broker your dealing costs will be high, whereas if you invest online your dealing costs will be low.

A traditional stock broker offers a variety of services in addition to just dealing. If you want advice that will cost extra, if you want them to manage your investments that will also result in annual fees usually of at least 1%. Dealing fees for a full commo stockbroker will usually be on a sliding scale with a minimum value, and as a percentage of the trade. A trade may also attract other fixed fees. If you hold securities with the firm it is inevitable that you will incur custody fees. High fees erode the value of a portfolio. A stockbroker wants you to trade and does not care if you buy or sell, any trade is good.

An online broker will commonly have a flat rate dealing cost of say £12 per trade, and if you shop around you may find that there are no custody fees. You may find that one trade at a traditional broker will equate to the cost of say 10 trades via an online broker. The online broker is therefore cheaper and gives you dealing flexibility, making you more nimble and less reticent to adjust your portfolio.

Some people and entities prefer to deal with a person and to have the comfort of a professional investor looking after them. It is your choice. If you go it alone via an online broker you save a significant amount in fees which stays in your portfolio.

 

4 Do not put all your eggs in one basket

This is the old adage which cannot be repeated often enough. Even though you may think it is a good idea to have a large holding in a sure fire stock it is inevitable that from time to time things will go wrong, and this will badly affect your portfolio. It is suggested that no more than 10% of your portfolio should be in a single holding, unless that is itself well diversified.

As a side note when investing into bonds be careful about having too much in long dated issues. They yield more but are inherently more volatile. If interest rates move up they will fall fast.

Also of note pay attention to the balance of your portfolio to bonds/cash and shares. Too much or too little in shares can be a mistake. Know your investment plan.

 

5 Avoid fees

If you pay fees they will reduce the value of your portfolio. You should be especially aware that certain types of investment have substantial fees which may not be readily apparent. For example a unit trust and similar will most likely have a spread of perhaps 3% between the buying and selling price. Any unit trust type investment will also have annual fees, many over 1%, and in addition there may be other fees to pay.

I have seen a unit trust with a 9.5% spread between the buying and selling price. I have seen a fund which invested into another fund and charged its own fees in addition to the fees applied by the underlying fund. Always look at costs and compare to other similar funds. Fees destroy performance. In performance tables fees are mostly disregarded which you need to be aware of.

Consider investing into low cost investment trusts and ETF holdings (Exchange Traded Funds) where the costs are usually small.

 

6 Be tax effective

Tax takes a chunk out of your money so always look to invest in a tax effective manner, say through an ISA account. This is particularly the case with gilts and bonds where interest is usually payable without the deduction of tax. In an ISA you keep all of your income.

 

7 Inflation

Be aware of inflation. Inflation erodes the value of the pound in your pocket. You need to beat the rate of inflation to ensure the buying power of your money grows. There are at least two official rates of inflation, although you may wish to go with your personal view.

 

8 Read widely and anticipate

One of the concepts in the investment world is the efficiency of markets in pricing in all known information which has an effect on a share. In my experience investors are sheep like and move as a crowd, disregarding any warning signs.

It is recommended that you read widely and form your own views of what may happen to economies and investments, and apply that to your portfolio. It can take an inordinate amount of time for views to change so make changes in a timely, manner but not too soon.

 

9 Be aware of hidden dangers

The investing world, as with banks, has changed out of all recognition over the past two decades. Be aware that as a small investor you are fair game to the numerous large predators out there. These days only about 30% of investors in a market are people, and 90% of trading activity is HFT algo driven (machines) which place trades in under 10 milliseconds, and can react to an inbound trade to a stock exchange and deal against it in that time. Ensure that when you place a trade you either get a sensible quote or place a limit, otherwise you will get a bad price and will have no recourse to a poor market trade.

 

10 Build your confidence through knowledge

Educate yourself by reading books and online guides. As you understand things apply that knowledge. Be aware of your limitations and think before you act. If something does not look right avoid it. If something is complicated keep clear of it.

Chezphil Emporium