A Logical Investment Strategy

Over recent weeks, I have been reviewing my investment strategy. When I first started this blog in Feb 2013, I wrote a number of articles which reflected my basic approach to the investing process. These are essentially a collection of guidelines which will benefit most investors - keep costs low, keep it simple, a diversified portfolio, start early etc.

Logical

These basic principles of investing gain traction because they produce a good result when used over a longer period and also because they make sense to most reasonable investors.

* Low Costs - it seems to be logical that if you invest in a fund charging 1.5% p.a., it is likely you will get less return for your investment than a fund charging 0.25% - this is hardly rocket science. Indeed all the research I have seen in recent years supports this. Here’s a link to a recent report by vanguard which is typical of many.

* A diverse portfolio - We all like to make a little extra money - but if you are anything like me, you hate losing money even more. The best investment strategy of all is the one that guarantees never to lose money - only one problem, such a strategy has yet to be devised.

The next best option therefore would be to limit any potential loss by selecting a diverse range of investments. As we probably all understand, as a general rule, its not a good idea to put all your eggs in one basket.

Investors can diversify their portfolio in several ways but the most common would be :

• Holding funds or investment trusts rather than a few individual shares;

• Diversifying assets between different classes - equities, bonds, property etc.,

• Geographic - a global spread of holdings. As can be seen from the chart - courtesy of Novel Investor, limiting your portfolio to just one country may not have provided the better returns - far better then to have a wide global mix (NB USA not included).

(click to enlarge)

* Keep it simple - “Everything should be made as simple as possible - but not simpler”  Albert Einstein.

As it is an option to hold a wide variety of diversified assets in a low cost tracker, why would you want to hold the same assets in 10 different funds?

Vanguard founder John Bogle says “Simplicity is the master key to financial success. When there are multiple solutions to a problem, choose the simplest one.”

* Start Early and stick with it for the long term - those who embrace the idea of investing, and I suspect this may well be a small percentage of the population, will come to it at different times. The earlier we can get going, the better as our investments will compound over time - also, the longer the period of investing, the better chances of a successful result.

The ability to see it through over the longer periods could well be the most challenging aspect of the investing process. Investing will usually involve some equities and these can be volatile - some investors, myself included, can become irrational during periods of market volatility. Asset allocation and rebalancing is an important part of the strategy to deal with this aspect.


Apply the Logic

I hold quite a diverse portfolio :-
20 or so individual shares,
a dozen or so investment trusts,
some PIBS and other fixed interest holdings, and
some UK income and global income tracker funds/etfs.

Lets look at each in turn in relation to the above logical basics :

Shares - 20 is probably a reasonable number to give some diversity and they are very low cost as apart from the dealing fee to purchase, there are no further ongoing costs charged by my broker.

Whether they could be regarded as simple for the average investor to research and monitor is debatable but for myself, as I get older, I recognise this has become more of a chore and I am starting to think I could do without the half-yearly perusal of the interim/final report etc. - not to mention the share price volatility. My shares in easyJet fell 10% this week after reporting its first interim profit for over a decade - logical or what!

Individual shares are probably the most volatile assets to hold in any portfolio - and the logical implications of this are that the emotional rollercoaster makes it more likely that some shares will be traded too frequently which in turn increases costs.

I can have access to a wider range of shares in collectives such as investment trusts and low cost trackers. This offers diversity and reduces volatility.

It can be quite fun to hold individual shares but from a logical point of view, I am struggling to justify a case for their retention.

* * *

Investment Trusts - they offer diversity both in the number of shares and other holdings in each trust but also give access to global markets. The costs vary, some are reasonably low at ~0.45% with the likes of City of London, others are nearer to 1.0%. As with shares, there are no additional platform costs with my broker for holding investment trusts.

I find them less volatile than individual shares however, they do use varying amounts of gearing and can trade at a premium or discount to their NAV so they are a little more complex. Against this is the advantage of their ability to pay a steadily rising income steam due to their being able to hold back excess income in reserves.

The fortune of the trust is dependent on the manager making consistently good calls - some appear to be reasonably competent and some a little more average.

I think, on balance, there is a logical case for holding a diverse basket of the lower cost trusts, particularly where the manager can demonstrate a consistently good performance relative to an appropriate benchmark over time.

* * *

Passives - it more or less goes without saying that these are all low cost. There are however some additional costs - 0.20% platform fees - for holding funds with AJ Bell Youinvest.

They are diversified, fairly simple to understand and implement - although with the funds you don’t quite know what quantity you have purchased and at what price until a couple of days later. Although I have not bought the fund yet for my own portfolio, the Vanguard LifeStrategy funds offer a diversified low cost one-stop strategy which could not be much simpler.

The income distributions are unpredictable as the fund or ETF merely pays out all the income received over the intervening period.

There can be little doubt, on most fronts, these are the most logical way to invest.

Conclusion

I am trying to take some of the complexity out of my strategy - make it more simple, reduce some costs and hopefully generate a little better returns.

I am wondering what response you might get from IBM’s Watson - surely one of the ultimate providers of logical solutions. I’m sure it can’t be too long before it will be possible to pose a simple investment question and the super-computer will come up with the very best logical strategy!

I feel sure Mr. Spock would suggest I dispose of my individual shares and possible some of the higher charging, lower performing investment trusts and divert the proceeds into one or two global index funds.

...but that's not logical Captain...

I probably need a little more time to consider the further changes to my investing strategy. It would however be good to simplify my investment portfolio a little more… as they say, slow & steady steps - provided they are heading in the right direction!

I wonder what Homer would do - probably have another beer!

Feel free to leave a comment if you have any thoughts.