When you invest your money, as opposed to keeping your savings in a cash bank account, you will need a broker to do the operational stuff for you.
Once you’re set up with a broker, you need to decide how much control you want to have over investment decision-making in your portfolio. There are three main choices, which represent decisions at differing granularities:
- Ask the broker to make all your decisions for you
- Invest in funds: Allocate your money to selected professional investment managers, with different specialities
- Invest directly in individual stocks/bonds, etc: this is the most granular form of investing
It is probable that your overall portfolio will be some combination of the above three, but it is important to understand the differences nonetheless. There are three main considerations – or questions to ask yourself – when thinking about your choice of decision granularity:
- How interested are you in investing?
- How much time and effort can you put aside for making investment decisions?
- How much does it matter to you to perform better than average, or better than others?
Let’s go through each of the choices and answer these questions from different perspectives.
Asking your broker to make all your investment decisions for you
This doesn’t mean you relinquish control over the ability to withdraw your money from your brokerage account, or indeed to put more money into the account. Those decisions are still yours to make. You also retain total control over the ability to ‘fire’ the broker and choose someone else to manage your money for you instead. But this is the least granular form of investing because it doesn’t require you to know anything about investing. You might choose to learn some of the basics, so that you’re not completely in the dark, but you don’t need to know much at all.
Managed services like this are available for investors at a every wealth level, but with differing levels of personalisation. At the highest wealth end of the spectrum, the service provider is usually called a ‘wealth manager’ or ‘private banker’. You’ll need at least £1m of investable assets to qualify for this service, and often much more. If you’re in this bracket and you’re struggling with how to choose a wealth manager, you can contact us and we’d be happy to provide some guidance.
Assuming you’re in a lower wealth bracket, the type of managed service usually available to you will be somewhat less personalised, and instead it will categorise you into a bucket with other investors that have a similar profile to you. At a minimum, your broker should ask you basic details such as your age, your overall wealth and possibly your income or other details. The point of these questions is to understand your risk tolerance – your ability and willingness to take financial risk – so that they can put you into the right bucket. When I say that the broker ‘asks’ you these questions, what I generally mean is that you’ll fill in an online form or play around with an online tool. Generally, providers of these services will protect themselves by stating up front that they ‘are not providing you with advice’, that ‘ultimate responsibility rests with you’, and that ‘if you provide inaccurate information then you might end up with the wrong investments’. This is all a product of the fact that at the lower end of the wealth spectrum, you are being averaged along with many other investors, as opposed to having a service completely tailored to you. That doesn’t mean these services are bad, you just need to know what you’re getting.
I think we’ve established that if your answers to the first two questions above are ‘not very’ and ‘not a lot’ then you might fit into this category. Likewise for the third question: choosing a service that puts you into a bucket with other investors with your characteristics will tend to mean that you end up with relatively average performance. Your broker may perform particularly well or badly relative to other providers of managed services, but everyone in your bucket will perform the same. If it’s important to you to ‘stand out’ somehow, or if you would like to talk about ‘your’ investment performance, then a managed service may not be for you.
Investing in funds
This is the most common form of investing for most normal people. Even those people who want to make minimal effort and have minimal interest in investment will often want to do some learning and reading about investment matters, and will want to feel in control of their investments. Further up the effort scale, this option requires you to have a foundational understanding of investment, so that you can build a portfolio appropriate for your financial objectives and constraints.
Funds are a form of collective investment vehicle. A professional investment team (the manager) at an investment management company will manage the fund on behalf of all the investors in the fund. While some funds are reserved for ‘qualified investors’, i.e. those who are either ‘high net worth’ or ‘sophisticated’ (they themselves are a professional but are investing for their own private account – like the authors at To the pound), most are available for anyone to invest in. For those funds open to all investors, the minimum investment size is typically about £25-£100 depending on your broker, and there is usually an option to set up a standing order to invest regularly into the account.
Each fund will have a clearly defined speciality, investment objective and set of constraints that govern what it can and can’t do. For example, a ‘large U.K. company stock’ fund will invest only in large companies in the U.K, and may have a benchmark such as the FTSE 100 that it will try to match or beat. Instead of being referenced to a benchmark, it may simply state a target return of, for example, 5% p.a. The fund will typically be diversified across many large U.K. stocks, as opposed to being concentrated in just a few. That spreading of your money across multiple investments is the primary benefit of investing in a fund. With just a £25 investment, there’s no way you could invest in all 100 companies in the FTSE100 seperately.
Since funds must keep to their pre-defined investment guidelines, you can typically expect to invest in more than one fund. For example, in the equity or stock portion of your portfolio, you may wish to choose a U.K. equity fund, a European equity fund and a US equity fund. You might, for example, think that Japan is an unattractive place to invest right now. You don’t have to allocate equal amounts to each fund, so you can invest more in the ones you like the most. Or you might choose to invest in a single global equity fund, where you allow the manager to choose which countries to invest in, removing the requirement for you make country or regional decisions. Remember that investing in other countries exposes you to currency risk.
Diversification is not just via spreading your money across countries or regions. You could decide to allocate to individual sectors or across different asset classes. You can also diversify across active and passive funds. The common theme with all fund investing is that each fund itself will be diversified across different investments within its pre-defined guidelines. So, if you invest £100 each in 5 different funds, which each have 50 different underlying investments, you’ve invested £500 across 250 different investments. That’s far more than you could invest in if you invested directly in the underlying assets.
Importantly, fund investing gives you enough flexibility to decide, if you want to, to invest in a manner that is very similar to the managed service above. Ultimately, by selecting individual funds to invest in, you could re-create the portfolio that a managed service would create for you anyway. Similarly, you can essentially ‘dial’ up and down the amount of attention your portfolio requires from you, by keeping it as simple or as complicated as you feel you want to.
Selecting individual investments
Professional investors themselves often don’t make particularly good investment decisions, so their funds often underperform or lose money. But before writing them off and deciding to do it all yourself, take a moment to ask yourself: do you really think you can do it better than a professional? This is the most granular form of investing and there are literally hundreds of thousands of stocks and bonds to choose from. In my experience, there are two types of ‘normal’ people who can perform better than a professional investor: a) those with an extremely good temperament, specifically a knack for avoiding or controlling the human behavioural biases that we all have to differing degrees, and b) those with specific industry or sector knowledge, such as someone who works in car manufacturing having special insights into their own sector. The latter type can be dangerously close to insider trading, so be careful not to cross the line.
Regardless of whether you are actually able to outperform the professional fund managers, it may be valuable to you to be able to tailor your portfolio even more closely to your own requirements. I would also add that investing directly in the stocks or bonds of individual companies or the bonds of countries may be a matter of taste as well. I always saw my private investment account as being like my diet: I wouldn’t choose a meal based just on nutrition and price but on taste. As long as my diet and portfolio are relatively well balanced, I’m not doing anything too stupid, and I’m aware of the risks, I feel comfortable with allowing myself to enjoy the process of investing. I may well have underperformed the professionals, but I’m meeting my goals, and that’s what matters.
Having said that, ‘doing something stupid’ is very easy to do, and ‘balance’ in your portfolio is incredibly elusive. So here are three laws to bear in mind if you are going to go down the route of picking your own investments
- Never take stock recommendations from anyone without properly investigating the stock yourself as you otherwise would, even if they are supposedly an investment professional. You’ve probably heard this one before. It’s very unlikely that the person you’re speaking to knows what they’re talking about. They may mean well, but for any number of reasons they may just simply be wrong. Wrong about the stock being a good investment. Wrong to recommend it (if they truly have special insights about the stock then they and you may be breaking the law by discussing it). Or wrong to suggest that the stock is a good fit for your portfolio. That last one is important to bear in mind when receiving recommendations from an investment ‘professional’: a professional stock-picker is unlikely also to be a professional wealth planner, and they are incentivised – both professionally and egotistically – for identifying stocks that go up in price, not for identifying assets that are a good fit for a specific person’s portfolio. Professional stock-pickers rarely talk to clients even in a professional capacity, so don’t trust their judgement in a private capacity. In fact, you are probably just a guinea pig for your boyfriend’s friend to express their ego, because at work they keep making bad stock calls. Investigate it objectively if you’re interested, but never invest solely on a recommendation
- Start with what you know, which is usually large well-known companies. There are easily enough large companies in the world to keep you busily reading for a long time, so focus on those. Maybe you shop with them regularly, or have a subscription with them. The number of professional stock analysts that have talked to your author about balance sheets and growth forecasts and have met senior management but have never actually bought the company’s product is pretty embarrassing. And consider the connection between this rule and the rule above. Random stock recommendations are often about small or awkward companies that you’ve never heard of, because it sounds more impressive. People don’t recommend large well-known companies because they know that, chances are, you know more than they do about the company already.
- Don’t try and be too tactical. If you like the company now, why wouldn’t you like it in 5 or 10 years’ time? Yes there is such thing as a ‘hot stock’, but don’t try and seek them out. Don’t think about it as ‘trading’, but ‘owning’. As an owner of a business, would you change your mind every year about whether you want to be an owner or not? A stock is a business, and by buying it you are becoming an owner. Only invest if you’re planning to stay invested for 5 years or more. I have very rarely divested from a stock that I bought, and even then would only sell if some important new information came to light, such as a fundamental change in business direction, or an accounting fraud (I’m lucky to not have been invested in a fraudulent business yet). Having a longer term outlook also helps you manage the inevitable emotional biases that naturally come along with investing in stocks, and a long term view is even more important when you’re doing it yourself than when investing in a fund, because funds usually have risk management processes designed to reduce bad outcomes.
In terms of what to actually look for when picking stocks, well, the ‘professionals’ go through quite an involved process, but we provide some basics in a forthcoming article.
So far we’ve only talked about picking individual stocks. We deem it even less likely that you’ll be picking your own individual bonds (your author certainly doesn’t) but see this article for some of the basics of bonds.
Combining the three approaches
Most likely, you’ll combine at least two of the three approaches to build your total portfolio. For one example about how this can be done, we can borrow and adapt a common portfolio structure from the fund management industry: the ‘core-satellite’ approach. In the industry this takes on a slightly different meaning, but for our purposes, the ‘core’ of your portfolio will make up 75-100% of your assets and be invested in funds or managed by a managed service provider. The other 0-25% can then be invested in individual stocks. This helps to limit the risk of your selecting losing stocks, while allowing you some flexibility to learn and enjoy investing. It also forces you to carefully consider whether an individual stock has really ‘earned its place’ in your portfolio, because you’ve only allowed limited space for individual stocks. In this article on diversification, we refer to the concept of ‘undiversifying‘. That is definitely not a technical term, or even a real word, but it can help you to frame your approach with respect to how much weight you assign to individual stocks.
We refer to lots of linked posts in this post. We hope that by following the links you can answer any questions you might have, but if anything is unclear in this post, or you have any questions relating to anything investment-related, please submit comments or questions in the section below and we’ll do our best to answer them.
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