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Why buy a share when you can buy a fund?

28 May 2020

5 minute read

However good a share picker you are, a single share or portfolio of shares is unlikely to ever offer you the diversification you could otherwise achieve by investing in a fund. So, why do it? Here, we consider the pros and cons of investing in a fund as opposed to a share.

Who's it for? All investors

The value of investments can fall as well as rise. You may get back less than you invest.

What you’ll learn:

  • Things to consider when investing in individual shares.
  • The benefits and drawbacks of buying funds rather than shares.
  • Learn more about the Majedie UK Equity Fund and the Artemis Income Fund.

If you are a regular reader of our missives, you will know that we like to expound the benefits of diversification. But, however good a share picker you are, a single share or portfolio of shares is unlikely to ever offer you the diversification you could otherwise achieve by investing in a fund. So, why do it? Here, we consider the pros and cons of investing in a fund as opposed to a share.

While the coronavirus pandemic has caused a widespread slump in global equity markets, for some, it has also created a swathe of investment opportunities. While there may be no guarantees that we have reached the ‘bottom’ of the market, some company share prices may appear to be too attractive to pass up. So, what’s the harm in scooping up a few of these ‘bargains’?

Diversification

Because companies and sectors don’t move in the same direction in the same market environment, it is important to manage volatility or reduce the risk of a particular investment by employing a diversification strategy. Diversification is all about spreading money across a number of different investments to reduce the risk.

Investing in a single share, or a selection of shares, listed on the UK share market runs the risk of a missed diversification opportunity and a general UK share market bias. In other words, this investment would be vulnerable to the vagaries of the UK market, as well as currency risk if some or all of the company/companies’ earnings are generated overseas.

Also, if you choose to invest in a single share you are relying on the commercial skill and expertise of one company’s management. However, if you invest in a diversified range of companies, you benefit from the average skill of several company management teams.

A fund, on the other hand, provides the quickest shortcut to a diversified portfolio. Funds make it easy for investors to build a diversified portfolio by reducing the volatility and potential gains and losses associated with holding individual shares. By diversifying, you won’t get either extreme at the ends of the spectrum – the performance will tend to be somewhere in the middle.

Concentration risk

Unless you buy a portfolio of at least 30 shares, you face the prospect of concentration risk where you are over-exposed to the companies you hold. Concentrated portfolios are less diverse because they hold fewer shares and may not offer exposure to all sectors in the market. As a result, the underlying assets are less likely to offer the same diversification benefits as holding more shares across a wider range of sectors. This is because the more shares you hold, the less likely they are to all move in the same direction all of the time.

However, if you choose to increase the number of holdings in your portfolio to avoid this ‘concentration risk’, you run the risk of having too much diversification which will only serve to increase costs and complexity. Researching, monitoring, buying, and selling a large number of shares can be both time-consuming and costly, and perhaps best left to the experts.

Market timing

No one knows when the market is at a ‘bottom’ or at its ‘peak’ and trying to time the market in this way can be something of a fool’s errand. We would always advocate time in the market rather than trying to time the market. Trying to time the market is a risk, and if timed incorrectly, can be a costly one at that.

Simply buying companies that have lost the most value is a valid strategy but only if you have done proper detailed analysis too. If a company is heavily indebted and has been forced to take out expensive debt just to survive, then the shares can become essentially worthless. This is often referred to as a ‘value trap’.

How well do you really know and understand the companies you are buying? You may like the fact that shares in BP and Shell have lost a lot of value over the recent past but do you really understand the future supply and demand for oil to know that the current share price is attractive? If you like the idea of investing in Carnival, are you sure that the company’s financial position is robust enough to survive not being able to offer any cruises for a prolonged period of time?

A fund manager will have a process for selecting investments, and has a team of analysts who undertake detailed data analysis, have access to company management, and who can assess the investment potential of each company before making a decision.

Income

Following the swathe of dividend cuts announced recently, there are now precious few companies which are still paying a dividend, and those that are, are likely to be paying a lower dividend than previously. To understand more on this subject, read our article on what these dividend cuts mean for you.

The key point here is that buying shares for their dividend income alone is still a viable strategy for income generation but only over the long term. You may not receive the same level of income you got in the past, but that income – which is now more affordable for companies – may be more sustainable than the higher dividend paid in the past. Whilst the number of dividend cuts and size of them is significant, lots of other companies have maintained their dividend, such as Legal & General (L&G). L&G believes that they have the cash flow necessary to pay the dividend and intend to meet their dividend payments for the foreseeable future. A fund manager has the resources, time and expertise to try to mitigate the impact of the recent cuts for the benefit of the investor.

Conclusion

Share-picking is not necessarily a bad thing but it is certainly not easy. Not all individual investors may have the ability or willingness to research and find a company that is financially robust, able to adapt to the currently challenging conditions, and is cheaply valued. This is exactly what professional share pickers do.

When it comes to delivering stable, inflation-beating returns over the long term, most investment professionals agree that diversification is the key to success, and should be an integral part of every investment portfolio. However, it’s important to remember that diversification can’t protect against losing money. The key benefit of spreading your eggs is sleeping peacefully knowing that, whatever happens, you’ll never have the worst performing investment.

Investing in a fund, rather than buying shares is a great way of achieving this and getting immediate diversification as the fund you choose will invest in multiple companies.

Some funds to consider

The Majedie UK Equity Fund and the Artemis Income Fund are two funds in our Barclays Funds list.

The Majedie UK Equity Fund (income units) holds a blend of cheaper companies as well as those offering more growth, such as St James Place. The Artemis Income Fund (income units) holds a portfolio of companies. The manager believes that some of these companies will continue to pay their dividends unhindered while others have merely delayed their dividends. Both managers offer investors greater diversification than simply holding individual shares. A fund does not guarantee better performance but it should offer a smoother investment journey.

Alternatively, the Barclays Ready-made Investments are just one example of a range of diversified funds which allow you to select the level of risk you are most comfortable with. These multi-asset funds invest across a range of asset classes and regions, offering a globally diversified one-stop solution for investors.

Neither the Artemis and Majedie nor our Ready-made Investments are the only funds that we offer of their type and they won’t be appropriate for everyone.

We don’t offer personal investment advice so if you’re unsure you should seek that independently.

Funds are designed for the long term so you should only consider them if you can stay invested for at least five years. All of these investments can fall in value as well rise; you may get back less than you invest.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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