A Logical Investment Strategy Revisited

Over the past year or so, 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 should 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.

* Create a Plan - a unique road map and strategy which broadly sets out some of the basics of why you are investing - time frame, what would define success and how you are going to go about it.
Do you select active or passive, possibly a mix of both?
What is your asset allocation and how will it change over time?
ISA, Lifetime ISA or SIPP?
Which low cost broker/platform will be used?

There is no perfect strategy. Different plans will suit different investors with different circumstances. I suspect the best plan is one which is more likely to ‘fit’ with the individuals psychological make-up and is therefore most likely to keep them in the game and get them to their destination.

* 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 0.15% - this is hardly rocket science. Indeed all the research I have seen in recent years supports this. Here’s a link to a 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 know, 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.

* 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.”

Years ago, a journalist asked Charlie Munger why more investors hadn't copied Berkshire Hathaway's approach to investing. "More investors don't copy our model because our model is too simple," he said. "Most people believe you can't be an expert if it's too simple."

* 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 minority 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 involve 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.

* Know Yourself.  I believe this is one of the most important aspects of the process but possibly the least understood by newcomers. The longer the time frame for the investing journey, the better the probability of a good return. However, one of the hardest aspects of investing is sticking with the plan when markets are volatile - especially equities. You will need a plan which you can stick with through the ups and downs and which meshes well with your personality.

Are you naturally cautious or do you like the thrill and spills? Do you seek instant gratification or are you patient? Are you more skillful than the average investor? Can you accurately predict the direction of the markets? Are you overly influenced by ‘experts’ or do you ‘do your own thing’? How would you react to losing 10% of your portfolio value?…25%?…40%….?

Charlie Ellis from ‘Winning the Loser’s Game’
“The hardest work in investing is not intellectual, its emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the best investment policy; its sustaining a long term focus at market highs or market lows and remaining committed to a sound investment policy. Its hard especially when Mr Market always tries to trick you into making changes“.

The basic idea is that the best strategy for most people is not only one that makes sense, but also one they can also stick with - (Joel Greenblatt)

* The Art of Doing Very Little. We need to give careful consideration to our strategy - asset allocation, low cost broker, active/passive etc. All this is probably best done before we start investing. The plan may need a few tweaks along the way but I believe, over the longer term, the better outcome will result from doing not very much once the plan is up and running.

This aspect of investing for me personally is possibly the most difficult to achieve and I am sure my returns have suffered due to the itch to tinker and constantly monitor.

Sometimes there is a good reason to make a portfolio change but in my experience, 9 times out of 10 it will be better to do nothing. Successful long term investing is developing a habit of saying ‘no’ over and over and doing nothing at times when doing ‘something’ could be a big mistake.

Apply the Logic

I hold quite a diverse portfolio - a few remaining individual shares, a dozen or so investment trusts, some fixed interest holdings and some UK income and global index funds.

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

For many years I have held individual shares in my portfolio mix however, when I came to analyse the contribution of these compared to my collectives in 2015, it was clear that they were clearly the weakest link in my strategy

Individual shares are probably the most volatile assets to hold in any portfolio - and the logical implications of this are 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 was struggling to justify a case for their retention and this led to a review of strategy.

* * *

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%. .

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 stream 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.

* * *

Index Funds - it more or less goes without saying that these are all low cost.

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. A little while back I reinvested some of the proceeds from share sales into the Vanguard LifeStrategy funds which offer a diversified low cost one-stop strategy which could not be much simpler.  My Lifestrategy 60 fund is a blend of stand alone equity and bond funds which together comprise around 20,000 holdings.

The income distributions from my UK Equity Income fund are unpredictable as it 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 have been trying to take some of the complexity out of my strategy - make it more simple, reduce some costs and hopefully generate a little better return.

Given the underperformance of my shares, it seems logical and sensible to reduce these and replace them with one or two global index funds.

The review of strategy seems to be working out. Over the past year, the index funds returned 17.3% compared to 14.4% for my basket of investment trusts and just 1.5% for the remaining shares.

It would be good to further simplify my investment portfolio… as they say, slow & steady steps - provided they are heading in the right direction!

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