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How to build and simplify an investment portfolio · On The Money

• 0:03
  Kyle Caldwell: Hello, and welcome to On the Money, a weekly look how to get the best out of your savings and investments. It's been a very eventful half of the year for investors. Stock markets have become a lot more volatile than they have been over the past couple of years, mainly in response to US president Donald Trump's trade war. Now the good news is that a lot of the losses that occurred early this year have been clawed back with technology shares in recovery mode. So in May, the average technology funds posted a gain of 8.9.
• 0:36
  That brought to an end two months of successive losses. So in March, the average technology funds fell by 10.4%, and in April, the average technology funds lost no point 8%. Due to stock markets giving investors a wilder rise, I thought it'd be worth taking a step back and dedicating an episode to how to go about building or improving an investment portfolio by examining some of the strategies that we put in place. Joining me to unpick it all is Interact investor Sam Benstead, who's making his successive appearance on the podcast, having appears in last week's Skin in the Game episodes. Sam, great to have you back on.
• 1:19
  Do you wanna give our listeners a brief flavor of what we're gonna be discussing, and then we'll get into it?
• 1:25
  Sam Benstead: Absolutely. So we're gonna start off by looking at what a beginner investor should be asking themselves and thinking about when making their step into the world of investing. We'll then move on to discuss the importance of position sizing and then explain some popular construction techniques like the sixty forty portfolio as well as the core satellite approach. And then, Kyle, I think you're going to treat listeners to your football analogy in how to build a balanced portfolio.
• 1:51
  Kyle Caldwell: Well, as you know, Sam, I do love both football and investing, so I'll take advantage of any excuse for me to bring the two together. We'll come to that later on at the end of the podcast. Firstly, let's discuss a beginner investor. So if you're investing for the time, it's fair to say that it can be very daunting. There's a lot of choice, too much choice arguably with thousands of funds, thousands of shares to help narrow down your focus and make decision making that bit easier, it's important to put a plan in place.
• 2:24
  And part of that plan is thinking about your short term and long term investment goals. Sam, could you explain what types of investments fit into short term and longer term goals? So what I would say
• 2:38
  Sam Benstead: to a beginner investor is that investing is like a risk spectrum. There are two ends, and investing in the safe ends offers you one thing. Investing in the risky end offers you something very different. So starting the lower risk, lower volatility end of that spectrum, you might have something like money market funds, which aim to replicate the returns on cash. They're very, very rarely gonna fall in value, and they'll just keep ticking up.
• 3:05
  Short term bonds are probably the next risky thing that you might want to buy, and then higher risk bonds that offer a bit more interest rate risk, and and higher yields are probably the next thing on that risk spectrum. And then we'd probably move into equities. So equities are just shares in a company, and there's lots of different types of equities. So on the lower risk end of those, you might have consumer staples or utilities, and then you have more adventurous equities that are a little bit more higher risk, so things like technology shares or or emerging market shares. So that's the thing you want to understand.
• 3:38
  And then the next thing I'll say to a beginner investor is that you can still actually reduce risk by diversifying even if you're in a riskier asset class. So owning lots of different shares reduces the risk that one company is going to make your portfolio go bad. So short term goals, we want to look at lower volatility, lower risk assets. But if you have a long term investment horizon, you're allowed to take more risk because the short term volatility shouldn't matter so much to you because you might be locking up your money for fifteen, twenty, or even thirty years.
• 4:09
  Kyle Caldwell: And in terms of risk appetite, this is a personal decision as you can only decide what level of risk you can tolerate emotionally and also relative to your financial circumstances and time horizon. If you'd like greater balance in your portfolio, look to own a multi asset funds, which is in the middle of the risk spectrum. So a multi asset funds owns both shares and bonds. Some may also have some exposure to alternative assets such as infrastructure and also maybe some property exposure. Now multi asset funds are potential great starting point for beginner investors to build their portfolios because they give you a ready made diversification, which helps to keep a lid on risk.
• 4:53
  Now I'd suggest as part of wider research, looking at multi asset funds that buy a range of tracker funds, which provide the return of a particular index. So these funds, they're low cost, and they provide effective exposure to both stock markets and bond markets. Among the options are Vanguard Life Strategy range, BlackRock MyMap range, Legal and General Investment Management's multi asset index fund range, and also Aberdeen's MyFolio index range. So funds in this in these ranges, they have different risk levels. In short, the more exposure to shares, the higher risk the funds.
• 5:33
  Other options to consider are our very own managed ISA range. So we have 10 funds that have different risk levels. Five of those 10 funds are catered to those who want to invest sustainably. And as I just mentioned, they have different risk levels that range from cautious up to very adventurous. As you'd expect, the riskier level the funds, the more exposure it has to equities.
• 6:00
  With our managed DICER, you're asked a couple of questions and then you're matched to one of our 10 investment portfolios. This helps to find the one that best suits you and the level of risk that you're comfortable with. We also have a range of quick staff funds, which are catered to beginner investors. These funds, three of them are managed by Vanguard Life Strategies range. They are the 20%, 60%, and the 80% versions.
• 6:26
  And we also have three actively managed multi asset funds from Royal London called Royal London Sustainable Managed Growth, Royal London Sustainable Diversified, and Royal London Sustainable Wales. So to check out either our managed ISA or the Quickstart funds, head to ii.co.uk. In terms of risk, I just wanna say that I do think there's also a risk of being too cautious, particularly for investors in their twenties or thirties that are investing towards their retirement, and you have lots of time on their side. Ultimately, if you take too little risk, you may not achieve your long term goals. Now many multi asset funds follow this sixty forty approach, which is a renowned investment strategy.
• 7:12
  Over the past couple of decades, this approach so 60% in shares, 40% in bonds. It saved investors very well. So, Sam, I'm gonna pass the baton to you to explain why it has worked well barring 2022, which was a year in which interest rates rose significantly.
• 7:29
  Sam Benstead: Yeah. So it's it's been a great strategy. And if you looked inside your workplace pension, you might find that the default fund you're invested in is a sixty forty stocks to bonds investment vehicle. So to understand why it's been so effective, you have to understand the risk profile of stocks and bonds. So the shares are there generally to provide the growth.
• 7:48
  These are parts of a business. You're you're entitled to share their profits via dividends, and also for companies growing, the share price should also be growing. So that's where the growth comes from, and then the bonds generally provide a bit more income and provide a counterbalance to the shares because bonds, generally speaking, will be rising in periods where shares are falling, and that's to do with the nature of bonds. So they are well, the prices of bonds are quite closely tied to interest rates. When interest rates are falling, bonds should be rising in value.
• 8:18
  When interest rates are rising, then bonds might be falling in value. But in difficult economic times, interest rates should be being cut by central banks to stimulate the economy, so you might be getting a bit of growth out of your bonds. You also get the income, so bonds pay a fixed return, and yields are about 4% at the moment for gilts, about five and a half percent for corporate bonds. So those returns on an annualized basis contribute to your portfolio. So taken together, you know, when stocks are falling, your bonds might be rising.
• 8:46
  When your stocks are rising, your bonds might be falling, but you create a good balanced portfolio.
• 8:51
  Kyle Caldwell: As well as multi asset funds, global equity funds can also make a great starting point for beginner investors as they provide diversification in having exposure to different countries and sectors. A recent podcast episode that we published on the June 5 delved into whether the global stock market is sufficiently diversified amid concerns that it may be too reliant on the fortunes of one country, The US, which accounts for around 70% of the MSCI World Index. I won't delve back into that debate right now as it was covered in that podcast, but in short, if you invest them for the very long term, taking a ten year plus view, this should hopefully give your investments ample opportunity to hopefully grow however the index changes over that next decade. But however, you can, of course, be more tactical and look to own funds that hold less in The US than the global stock market. That's, of course, another approach that can be taken.
• 9:50
  In terms of global funds, Sam, could you run through some of the options that will potentially make a good starter fund for a beginner investor?
• 9:57
  Sam Benstead: Yeah. So there's a couple of highlight from our super 60 list. This is where our fund research team put together a list of ideas that they really like, and and they work hard to research fund managers and look at fees. And it's generally a great starting place for inspiration. So the two global funds that really stand out to me are their SPDR MSCI World ETF.
• 10:19
  So that's the ticker SWLD, and this just tracks the performance of the MSCI World Index, and the fees are 0.12% on that. So if you just want basic exposure to global shares from the developed world, that is a really, really good starting point. But as you mentioned, Kyle, the hidden risk in that is that it's about 70% invested in US shares, which has been one of the reasons it's done so well, but actually could come back to bite it in the future if US shares keep falling or alternatively, the dollar weakens, so actually your return in pounds goes down as well. A really nice fund to hold alongside that could be Scottish Mortgage Investment Trust. So this doesn't look anything like the MSCI World Index.
• 11:05
  There's some private companies in there. There's some smaller companies in there. There's some shares from emerging markets in there, and the goal of the trust is to invest in the most innovative companies from around the world, be they public or private. And this is a very volatile fund, but over the long term, returns have been fantastic, and the fund managers are very experienced at picking global growth winners. There were early investors in Tesla, Nvidia, and Amazon, but actually have been quite ready to sell some of the winning shares over the past couple of years.
• 11:36
  So there is perhaps a conservative approach to innovation, and they're not gonna go all gung ho on the latest winners.
• 11:43
  Kyle Caldwell: And as Sam mentioned earlier, in terms of how a fund invests, there are different risk levels. So on one end of the risk spectrum, the low end, there's money market funds. And then at the high end of the spectrum, there are things like Latin American funds or funds that invest in a single country like China or India. Global funds will broadly sit in the middle towards the high risk end. However, within the global sector, there are also different risk levels.
• 12:09
  The Scottish Mortgage, due to its investment approach, invests in lots of technology trends, tries to find disruptive growth businesses. That's at the high risk end for a global funds. However, there are others that are a bit more balanced, and two that I would suggest that are more steady, Eddie, are f and c and Alliance Trust. So both of these investment trusts operate under a multi manager model. So what they do is they outsource the decision making to a range of for managers, and they all have their own separate portfolios within those investment trusts.
• 12:44
  As a result, both those investment trusts own hundreds of different shares, so that gives investors a great deal of diversification. And when you're starting out, one fund may well be enough, and then as your portfolio grows, you can then introduce more positions. However, that's only a decision that you can make yourself. But one thing I've been thinking a lot more about over the past year or so when building a portfolio is position sizing. And the reason why I've been thinking about it a bit more is because since last summer, I've been writing a weekly piece for The Telegraph.
• 13:21
  It's called rate my portfolio. So I've been doing it while my colleague, Victoria Scholar, our head of investments, is on maternity leave. So what happens is Telegraph readers, they send in their portfolios, and I'm asked to critique it and offer my thoughts. And one thing that crops up time and time again is that I see some portfolios that are five, ten years away from retirement. I mean, a very large positions in a single fund or a single share.
• 13:48
  I've seen on a number of occasions now very large positions of 50% or more. And the other thing that I often see is that portfolios have very small positions. They have a small tail of holdings that are 1% or less. Now for me, having such a small holding makes it very difficult for that position to have a meaningful impact on the portfolio's overall returns. Now one approach that can help investors think about positional sizing and how to structure a portfolio is the core satellite strategy.
• 14:21
  Sam, I'll hand it over to you to explain how this strategy works.
• 14:26
  Sam Benstead: Yeah. So this is a really useful approach, and actually, it's one I used myself. So the core allocation, which I think should be about two thirds of a portfolio, could offer exposure via active or passive funds to global markets and perhaps UK equities. So there you get a slice of what global stocks are doing, and hopefully, you should get some steady returns without too much volatility. As we've mentioned, if you're all in a global funds, you might actually actually be quite exposed to The US there.
• 14:54
  That's why you might want to balance a global tracker with maybe a UK market tracker or a Europe tracker just to add a bit more diversification. In this portion of the portfolio, you could actually just opt for a multi asset fund that owns a a mixture of of different index funds from around the world to give you that built in diversification. And then on that satellite 1, here you have a bit more license to be adventurous, so you might want to add some some spicier ideas to your portfolio. This could be tech shares, emerging market shares, biotech, value equities, anything that you think could outperform the market, and you can actually have a bit more fun here. So if you're really into technology, then you might see the potential of AI and buy a fund specializing in AI equities, or you might even buy some shares yourself.
• 15:42
  If you are close to a sector or there's something you feel very strongly about, then this is the place where actually you can add in a bit more risk and let your personality shine a little bit more in your portfolio.
• 15:53
  Kyle Caldwell: And as Sam mentioned, in terms of the amounts, around two thirds is the rule of form to have in core holdings. And these holdings, they're dependable holdings that you think over a full market cycle, they should deliver for you, and they're not gonna give you any sleepless nights. Whereas the satellite partner portfolio, as Sam mentioned, the potential here is to give a portfolio more spice and invest in more adventurous areas. So say if you have 70% in core holdings, you could consider having three or four core positions that are 10 to 15% each. That's not financial advice.
• 16:29
  That's just me thinking out loud. And in terms of the satellite part of the portfolio, so if you have 30%, then you could consider having six holdings that are 5% each. Before we wrap this episode up, I'll just briefly go through my football analogy. So I think how football teams set up the players on the pitch, you can draw comparisons with how to build a portfolio. So there's different roles, different risk levels.
• 16:56
  So in football, you've course, you have goalkeepers, defenders, midfielders, attackers. So for the goalkeeper, that's where, say, a money market funds can come into play. This is the lowest risk type of fund. It's an alternative to holding cash elsewhere in defense. That's where you can have bonds.
• 17:15
  And we've we've spoken about on the podcast, the $60.40 portfolio. Bonds give portfolio defensive ballast, which can be very handy when stock markets are going through a volatile periods. In the fields, this is where you can have your core holdings such as index funds or ETFs that invest globally or indeed actively managed funds that invest globally, which we spoke about earlier on the podcast. And in terms of the other ends of the pitch upfront, the attackers, this is where you want your investments to the the most adventurous that can potentially add the most value for your portfolio, and that's where you can think of things like emerging markets, smaller companies, and to invest in certain themes like technology or also biotech or also invest in single countries like China or India?
• 18:03
  Sam Benstead: I think we can actually stretch that football analogy a little bit further. So in the Premier League, it is now rare to see managers given a lot of time, and the same is true with active fund managers as well. So they're often changing jobs. They're being poached. They're being pushed out if performance isn't up to scratch.
• 18:19
  So as a DIY investor, it's really important to keep tabs on your active fund to make sure it's sticking with its investment approach and the manager that you backed is still in charge.
• 18:29
  Kyle Caldwell: And just to add one more analogy, so funds are in a sector, and this is the most relevant sector to the way in which the funds invests. And within that sector, their their performance is pitted against other funds. And you can find on Interactive Investor and also places like Morningstar and TrustNet. You can see how the fund has performed in its sector where it ranks over various time periods, one, three, five, or ten years. And I think this is a great way to assess with an active fund whether it is adding value over other active funds and indeed the wider market.
• 19:06
  My thanks to Sam, and thank you for listening to this episode of On the Money. If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. If you get a chance, leave us a review or a rating in your podcast app too. You can join the conversation, ask questions, and tell us what you'd like to talk about via email on ocm@ii.co.uk. And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the interactive investor website at ii.co.uk, and I'll see you next week.