Reviewing your investment portfolio

Welcome to Word on the Street's Personal Finance podcast from Barclays UK where our experts share their knowledge and insights to help you become a better and more confident investor. In this fourth episode of our Word on the Street Personal Finance series we look at how to start investing in the right way, covering what is investment risk, the most common traps that investors too often fall into and how an investor's individual personality can influence their investment decisions.

PHIL ATTREED: Hello and thank you for joining us for this the fourth episode of our Word on the Street Personal Finance series. In this episode we'll follow on from episode three that looked at what makes for a good investment portfolio. This time we'll be focusing on top tips to start investing in the right way, things like how much risk should investors take, active versus passive investing, what traps do investors fall into, and how does my personality influence my investing. I'm Phil Attreed, Barclay's Head of Investment Consulting and for this episode I'm joined once again by Rob Smith, our Head of Behavioural Finance and Mike Haslam, Investment Funds Director. Rob, we discussed risk a fair bit in episode three, now investing absolutely has to involve risk as the value of any investment can fall as well as rise in value, but you can choose the degree of risk you take through the way you invest. Holding a good mix of diversified, basically varied investments over the long term you can significantly reduce the risk you might face. However, investing is still often characterized as extremely risky and therefore to some people it's something only to do once you've saved for all of your goals. It can therefore I suppose be perceived as an activity for the wealthy, why is it seen this way Rob?

ROB SMITH: I think it's quite natural that investing seems very risky to people especially those who are new to investing so I think the thing to be aware of is generally we're all quite loss-adverse creatures, a loss tends to hurt us quite a bit more than a gain of the same size feels good for us. So when it comes to investing we tend to have this short-sightedness because our perceptions of risk which we base our decisions on whether to invest or not, are not necessarily aligned to the sort of long-term reality which is what most of our investment objectives are set over, so investment in markets can seem very risky because we're exposed to short-term movements through the media, and every time you switch on the television you may see the level of the FTSE100 reported that day, and these daily movements often are downwards as well upwards and can seem quite random and indeed over a short time horizon of a day or a week or so they are very risky. Now, however history has shown that in the past the longer that you're invested for the less likely it's been that you've got back less than you invested and started with but we have to caveat that and say past performance is not a reliable indicator of future performance and therefore you do need to accept that no matter how long you hold them for they may be worth less than you paid for them when you need them.

PA: So I suppose Rob the million dollar question is how much risk should I take or indeed do I even need to take?

RS: So I think the latter part of that question is arguably the more important, thinking about your goals and what you to want to achieve from your investments is arguably one of the most important things. So if you're younger and you're just saving for the future, maybe your retirement, your pension you probably want your money to grow to allow you to do more in the future than the amount of money you can save right now, whatever that may be. Whereas if you're nearing retirement you may feel like you know you've got enough assets built up and actually you just want to protect them maybe from inflation and from losing real value.

PA: Okay so the need to take risk will vary from person to person but there are other things I should also consider right?

RS: Yes, exactly, so there are two other things, or two sort of categories or things you want to think about. Firstly, is your ability to take risk and that means you know the possibility of ending up with less which will depend on your circumstances. So to give an example, if you don't have an income and rely on the interest and the dividends and the income from your investments then you know this will reduce the amount of risk you can afford to take with that pot because obviously you're reliant on that for your income. I think then finally and really importantly you need to think about and consider your what we call financial personality, your attitudes towards taking risk. So are you happy to increase the chances you may lose money for the possibility of greater returns in the future that a higher risk portfolio may provide you with. Will you be able to stomach the larger short-term movements that one that a higher risk strategy would expose you to. Once you bring these together then you can manage your investments to a target mix of assets suitable for your level of risk.

PA: Thanks Rob, some useful pointers for new investors to think about there. And so clearly none of us have a crystal ball but what kind of returns should I be expecting from various types of investments?

RS: So as you say no one no one knows what their returns may be for individual investments, or in the short term, but if you look at broad groupings of investments similar characteristics, what we tend to call asset classes in the industry, for example shares of companies in developed countries is one example, and over a longer period of time then expectations of what risk and return may be are a bit more reliable. Now there are exceptions but for most major asset classes groups of investments, riskier ones tend to yield higher returns. So I'll start with equity, equities generally considered or should I say stocks and shares, also known as equity is generally considered the riskier asset class and generally has higher returns. Now expected returns are mainly dependent on the rate of earnings growths for those stocks, the companies behind those stocks and shares, which in turn is linked to economic growth. So think about GDP, now long-term growth is plausibly slower today, maybe due to various factors like demographics and slower productivity growth, and as such the expected return for developed market equities may be lower than what historical experience suggests. Now looking ahead what can we say, a level of between maybe three and seven percent is realistic for people to think about for expectations. Now whilst not electrifying especially the lower end this should still give you a decent chance of beating inflation. Then if we think about bonds, the other kind of major group of investments, then the best predictor of expected returns are interest rates. Now currently 10-year UK gilts, which is bonds issued by the UK government, the return is, sorry the rates are about 0.5%. Now from a historical perspective this is very low, to give you some context the interest rates for this were was about three percent after the global financial crisis, now this low rate suggests that expected returns from today may be lower than in the past.

PA: So Rob just picking up on a couple of technical terms in there, so firstly earnings growth, of course this is essentially the change in income that a company makes from whatever it does from one year to the next, and this clearly impacts the profits it makes and I suppose basically how attractive the shares might be to investors. We also talk about inflation quite a bit, as this is a measure of the rate at which an average basket of selected goods and services that everyday people use, how much that basket increases in value over a period of time usually a year. For many people, it's important to them that their savings and investments at least keep pace with this this basket of goods and services with inflation otherwise their ability to maintain a lifestyle may be impacted, particularly over a longer period of time. And this is I suppose one reason why savers have quite rightly been concerned in recent years since that financial crisis that you mentioned back in 2008, which is quite a long time now, it's why savers have been worried about very low interest rates and should be concerned about the impact inflation has on that. Anyway let's move on to look at some of the traps we see investors falling into. One I think I've seen most often is what we on the team call barbell investing. This is where investors seek out exciting returns with a very small part of their investable pot, but then they hold far too much cash versus what they actually need, to compensate for the risk that they're probably feeling about those more exciting investments. Ultimately they often end up disappointed with the high-risk investors they maybe don't perform how they expected and they would have been much better off taking a more balanced, basically boring approach with all of their available investment pot. Of course as we've discussed before, you should still absolutely have a cash pot for emergencies and for any short-term spending before investing and this amount will differ depending on your circumstances. Turning to you guys, Mike, Rob what have you seen?

MIKE HASLAM: Thanks Phil, I often come across clients who follow the index level of the FTSE100. The FTSE100 is the main index of the largest 100 company shares, which are listed on the London Stock Exchange, and they tend to focus on this as their reference for investments, and this is not a surprise bearing in mind that the FTSE100 features so heavily in the TV news, newspapers, finance publications, but the problem is it ignores two important points. Firstly, is that there are many more varied opportunities for investment than within just this index, and that a diversified managed portfolio generally doesn't react to news flow with anything near the same amount of headline grabbing movement that might affect the FTSE100 index. Secondly, the index level, so this number which is quoted on the news every day doesn't include the income returns that investors receive from company dividend, and this income has had a significant element of overall returns over time, so I would suggest investors look to total returns from their actual investments rather than focusing on index levels which you read about in the news.

RS: For me the thing I see most is investors worrying about whether now is the right time to be invested and to get invested, so try and time when they invest, and see it very much as sort of a binary decision. So the reality is that it never feels a good time to be invested and our emotions can often act against our best interests as investors, a bit like a big move in in personal circumstances, it often feels easier to maybe delay the decision to a little bit later in time. The easiest time to get invested is when markets are going up and there's positive news around and this is when it feels emotionally quite comfortable to be invested, but this tends to be when the price of investments are higher and it can be difficult to stay invested when prices are falling and there is lots of bad news around. Now stock market falls earlier this year show that many individual investors sold their holdings near the bottom of the market because actually it's very difficult to resist some of the urges, so we see time and time again that it's much easier emotionally for us to get invested at the top and sell at the bottom, which obviously isn't a great long-term strategy.

PA: Thanks Rob, we'll definitely come back to investor psychology in a short while but firstly in episode three we talked about passive trackers and active fund managers, how do I know what's right for me? Rob let's start with you and then we'll turn to Mike

RS: So I think from my point of view the thing to point out is that these days you can invest in an index including its dividends as Mike was talking about a little bit ago, and be invested in a very broad mix of investments across different industries, across different markets and geographies very cheaply. Just because you buy a fund that is active does not mean that you're always going to get better returns than a passive tracker fund. Now there are lots of active managers out there and many of them don't perform as well as the index or the market that they're trying to beat, and I'd say as an individual investor, think about when you're going to make investments into active managers and make sure you've got good reasons to do so and understand the sort of fees you're going to be paying in doing so.

MH: Yeah absolutely, but we at Barclays do believe in active management, we believe fund managers can be identified as potential opportunities to perform well on a consistent basis. Now our team at Barclays who manage money for our clients by passive funds and by active funds, but when we buy active funds we have to be absolutely certain that they are going to be better than passive funds because they are more expensive. We therefore put immense amount of time and resources into researching a wide range of funds and managers out there to find these opportunities that we believe are the very best. There are some good active funds out there but they can sometimes be quite difficult to find.

PA: They certainly can Mike. Now you also work on the teams within Barclays on how to find the best information on investments, where would you suggest our listeners get what they need to feel better informed and comfortable with individual investments before they put their money in?

MH: There are various documents published by the fund management companies themselves and these are documents such as fact sheets, which basically a sheet full of facts and there's a document called a KIID, which is a key investor information document and these have all sorts of information on them, things such as costs, the risks involved, they will tell you whether the fund invests in risky areas such as emerging market, it gives you usually the name of the manager which you think is that relevant, well actually yes, because then you could look up that manager and see how long he or she has been managing this fund or other fund, look at their history, look at their experience. These documents will also show you examples of companies that they invest in, and of course these documents will explain what the fund is actually trying to do, it will tell you the objective of the fund. But also when you look through these documents there will be performance quoted on them, we need to be mindful of past performance. Just because a fund has performed well in the past does not mean it will continue to perform well. We carry out a lot of work to understand if a fund's past performance is due to skill or it's just down to luck, remember if you're in doubt about investing you should seek independent advice.

PA: Thanks Mike, so turning back to that earlier concept of investor psychology at Barclays we understand the importance of investor psychology, and we've been using our own insights of individuals financial personalities since around 2007. Two of the most useful aspects that I've used with some of my clients over the years are around risk perception and composure, so basically these tell me and the client how they feel about the process of taking the first steps into getting their cash invested, and then also how they will likely feel along the way as they read headlines and they experience the ups and downs of investing. And I don't just use these with clients, I know my own weaknesses from the work that we've done and I also think about how that might impact my family as well.

RS: Why don't you share some of those with our listeners, I think that might be really insightful Phil.

PA: Okay Rob. Well it's no surprise that given my job and experience that I don't have a problem investing spare cash when I have it and I know that I don't need it anytime soon. It may come as a surprise though that my weakness is actually composure, maybe because I'm always reading news, and thinking about what might happen next. But knowing this is important for my investing and also important for my clients actually is they don't want my personality reflected in their investment strategies and this isn't something that all investment managers will have the benefit of. I'm conscious not to react immediately to news and always look for additional information that challenges my initial instincts and responses. I also try not to check the value of investments too often as it's the longer term valuation that I'm actually really interested in. And for my family who have less experience, I spend time simply explaining what I expect the long-term outcomes of decisions that we're looking to make will be, and they to be honest are a lot less interested than I am in investing. I suppose I chose to work in the industry but they like most people would like more available to spend in the future, so Rob, you work with all of the decision makers in our business, what tips have you got here?

RS: The first thing I'd say is if you're going to be a successful investor understanding and managing your potential emotional reactions are as important as any technical skill. Now it's often seen that you know or some people believe you know investing, is this world for people you know who have all this time and expertise to get into the weeds and understand the ins and outs of every company, but the reality is as we've talked about in the last couple of episodes that you can make life a lot easier for yourself, and so actually understanding your emotional proclivities and what that might predispose you to as an investor is very important. Warren Buffett who's one of the most well-recognized, successful investors that exist today, had a very good quote where he said “the most important quality for an investor is temperament, not intellect”. So it's important to acknowledge your own characteristics, your own temperament and understand these when they might be affecting your choices.

PA: So that composure element even being recognized by some of the most successful investors out there. Rob, Mike, maybe a few follow-on thoughts some tips to finish with.

RS: For me the first thing I'd say is, as we talked a little bit about earlier in the podcast, is to really spend the time to understand what the appropriate level of risk when it comes to investing is, for you to think about your goals, your finances, your personality, because the reality is unless you go and pay for investment advice, no one's going to do that for you, so it's worth spending the time to do that, to really understand what the appropriate level of risk might be for you. The second thing I'd say is a follow-on, that is when you're making your investments think about the investments you have and look to manage those to that appropriate level of risk, and so you'd want to target a mix of equities and bonds, depending on stocks and shares and bonds, depending on the level of risk that you're looking to aim for and that's suitable. Now you can make this a lot easier for yourself by investing in funds as we've talked about before, and there are funds that invest in various different asset classes and aim to provide you with a level of risk, and you often see that these labelled as cautious or balanced or growth as different labels for different levels of risk.

MH: Two points really, first one I would take Rob's last point one step further, once you have your diversified portfolio, rebalance it on a regular basis, basically to make sure that your portfolio today still looks like the portfolio you originally invested in. And secondly, understand the different fees you would incur for your investment and if they're worth it, think about the value for money you're getting for the investments that you have.

PA: Thanks Mike, your rebalancing point is an important one and of course this should be done for investors who invest in a more diversified managed fund. Just a couple of final thoughts from me to finish on, firstly having determined what you can afford to invest put it to work as soon as possible. And secondly setting up regular contributions if possible, so planning to invest and increasing the amounts whenever you can, automating payments means you're far less likely to let emotions or distractions get in the way of getting invested and staying invested over time.

Thank you both for joining me once again and thank you our listeners, hopefully some thought-provoking insights in there for you today. As always you can listen to our regular Friday podcasts on the latest markets and investment thinking, and we'll be back soon with the next episode in our Personal Finance series with Caire Francis and our Chief Executive talking about our new investment service Plan and Invest, and how it will address some of the challenges for investors seeking advice and a simple solution to long-term investing.

All investments can fall as well as rise in value and their past performance is not a reliable indicator of future performance. This podcast is not a personal investment recommendation.