There are more opinions as to what makes a good investment strategy than investments themselves. So, how do you make sense of it all? One overriding principle that will serve you well is to adapt James Carville’s famous mantra: “It’s the evidence, stupid!” Okay, we changed ‘economy’ for ‘evidence’ to make our point.
If you base your decisions on empirical and proven evidence, you can’t help but make intelligent investment decisions. At Capital we call this Intelligent Investing™. Intelligent Investing comprises four effective investment practices which it makes sense to adopt.
1. Build a well-structured portfolio
As the parable of the foolish man tells us – don’t build your house on sand. Evidence shows that returns rarely benefit from fund managers who try to pick the next ‘winning’ company. Or those fund managers who believe that only they can ‘time’ the markets. This is called ‘active’ investing, which involves the appearance of activity. When you hear this, just think ‘headless chicken’.
Structuring a well-thought-out blend of investments should be at the heart of your strategy. Your portfolio ‘ingredients’ will dominate the returns obtained during your investment lifetime1. You don’t need to take on the added risks and costs of active management to get a smart outcome.
2. Use diversification to manage risk
No-one knows what the future holds so don’t put all your eggs in one basket. Invest in an ideal blend of the world’s most successful companies (shares). Add a pinch of commercial property on a global scale. And season your portfolio with high-quality government bonds (gilts).
It has been proven that small companies outperform larger companies over the long-term. Small companies carry a higher investment risk than large, stable and profitable companies. Lower risk government and corporate bonds with high credit ratings give you better protection than lower credit bonds (but with potentially less return).
Use small companies as your growth driver, and investment-grade bonds as your defence. Nobody said investing was easy, but it can be simple.
3. Avoid costs at your peril
The cost of investing can eat away at your investment returns. Costs can be compared to dry rot or woodworm. By the time the problem is obvious, it can be too late. Unfortunately, trying to uncover the true cost of investing is very difficult. A real example may help:
Railpen is the pension scheme for current and former railway workers. In 2016, there was £21bn in the scheme. The pension scheme trustees believed that the ‘cost’ of the City fund manager fees was £75m. The trustees decided to take a deeper and closer look. The true cost came to £290m, almost four times as much. If this was a shock and surprise to professional trustees, it’s time that you asked the same questions.
What might seem like modest costs at the outset can compound into huge amounts over the years. Investment industry costs are high, particularly those related to active managers. The costs of investing don’t end at the annual management charges of your fund manager. Additional costs can also be offset against the fund’s performance, which eventually roll up into the ongoing charges figure. Yet that is not all. When a fund manager buys and sells, they incur transaction costs, which eat into your returns.
Imagine two twin sisters who both have the same sum to invest. They make different decisions. Sister A has a portfolio with an annual charge of 0.3%. Sister B is being charged 1.5% a year. After 40 years, sister A was amazed. She had a staggering 65% more money than her twin sister2.
Even when investment returns are the same, charges corrode and eat away at your investment pot.
4. Control your emotions
The human brain is hard-wired to be poor at making investment decisions. Dan Ariely, along with a number of other psychology professors, founded what is known as behavioural economics. Their research is all about poor investor behaviour. People battle between greed and the desire for reward against the fear of uncertainty and loss. This causes them to make irrational investment decisions.
There's no shortage of examples of emotionally-driven decisions made by impatient and nervous investors. Ultimately, bad behaviour destroys your wealth. Research as revealed that on average, this bad behaviour may cost you about 2.5% per year in lost returns3.
What could this mean to you? Let’s take those twin sisters again. Each sister has £1m to invest. Sister A is the well-behaved rational investor. Sister B is poorly behaved and an irrational, headstrong and emotional investor. After 22 years, sister A should have £1m more in her pot than her twin sister. Keep calm and carry on rules the day (based on an investment return of 7.6% a year and charges of 0.3% compared to 1.5% over 22 years).
Capital believes in the design of a disciplined, systematic and easy-to-use investment process. Its ongoing adoption is central to your success as an investor. It helps reduce the ‘behaviour gap’.
Invest like a scientist
Capital’s approach to investing positions financial planners as risk managers rather than just performance managers, as financial advisers have traditionally been. Capital employs an intelligent investment approach based on years of empirical academic research and evidence.
This tried and tested system provides the discipline that is required to avoid the pitfalls that all investors like you face. It makes investing simpler and easier.
To find out about Intelligent Investing™ and see how it could work wonders for your wealth and wellbeing, contact us today. One of our chartered financial planners will be happy to arrange a no-obligation conversation on how we can help you achieve more for less.
1 Brinson, Gary P., Hood, L. Randolph, and Beebower Gilbert L., (1986) ‘Determinants of Portfolio Performance’, Financial Analysts Journal, vol. 42, No. 4, pp 40-48.
2 Sharpe, W. F., (2013), The Arithmetic of Investment Expenses, Financial Analysts Journal, Volume 69 · Number 2, 2013 CFA Institute.