6 simple steps for wiser investing and a better chance of higher returns

• Posted on March 31, 2016
• by Nana Kwesi Coomson
• Comment

At the risk of adding to an already extremely crowded market, a recent dinner conversation with a friend made me think about trying to distil some thoughts on how to invest wisely into a simple plan.

I can’t lay claim to the original thought behind these tips, nor would I want to. Instead, these are ideas that I have gleaned magpie-fashion from investors I have spoken to – or read – whose wisdom seems to shine the brightest. 

+2

Hatching a plan: Can investing wisely be distilled into six simple steps to make more money?

1. Spend less money – invest the bulk of what you save and think long-term

In an increasingly have and have-not world there’s a danger in the simple suggestion to spend less money. There are many people in modern-day Britain for whom spending less in not an option – they struggle to actually have enough to cover the essentials.

I wouldn’t seek to tell them to spend less from my position of comfortable financial privilege. For the purposes of this though, I will assume that those reading an article titled Six simple steps to wiser investing have some money to spare.

Many of us could spend less money. That doesn’t mean fully embracing an ascetic lifestyle but simply trimming back the unnecessary, avoiding waste, and not paying over the odds.

A lot of stuff can be filed under the not paying over the odds category, not just discretionary spending. The big ones are your essentials, such as a mortgage, energy bills, credit cards and loans, car and home insurance and other similar bills.

Shifting these can save a huge amount of money. Mortgages are pretty much as cheap as they have ever been right now, there are lots of people paying at least a hundred pounds a month more than they need to. That’s £1,200 a year they could be investing instead.

Spending less money doesn’t mean forgoing all fun. Life is too short not to enjoy yourself. My personal theory is that I am unlikely to spend my final days fondly remembering that snowboarding trip I didn’t go on so that I could put some more in my pension.

Just make sure that your discretionary spending counts. Be judicious and sparing. Buying good stuff helps here.

It’s hard to find someone you can rely on, even yourself.

A regular monthly payment or direct debit out of your account tends to be a far more reliable investing companion that your best intentions to move the money yourself.

The latter opens up a host of opportunities for forgetting, diverting the money elsewhere, or investing it in the wrong place.

It’s all too tempting to invest too heavily in the thing that’s done well and is now expensive and too lightly in the thing that’s done badly and is now cheap. This is fine if you are employing a momentum investing strategy, but most people aren’t.

The beauty of regular investing is something called pound-cost-averaging. Essentially, by sticking the same amount into the same decent investment over the long-term you benefit from the stock market’s rise and fall. When the market is down and things are cheap you get more for your money, when it goes back up you benefit.

Despite what the rather disappointing performance of the FTSE 100 over the past 15 years tells us, shares do rise over time.

Over the past 114 years the average real return (after inflation) of UK shares has been 5.1 per cent a year, according to the Barclays Equity Gilt study. That compares to 1.2 per cent from UK Government bonds and 0.8 per cent from cash.

Another handy aspect of regular investing is that it removes both lump sum inertia and the temptation to try to time the market. The great fear in putting a chunk of money into investments is that the market will promptly take a dive. Timing the market is notoriously difficult. In fact, one of Britain’s top performing fund manager’s Mark Slater gave our readers this investing tip last year.

‘Market timing is very difficult for everybody. One person in a hundred is generally good at it and they should keep doing that,’ he said. ‘The other 99 people if they’re not good at it shouldn’t try and be good at it.’

Do yourself a favour, get money out of your account after payday each month and put directly into your investments. Do check those investments are still up-to-scratch at least once a year, however.

3. Asset allocate – don’t doze off here, this is potentially the most important thing you’ll do

Asset allocation. Zzzzzz. There is possibly no phrase in mainstream investing more likely to send people to sleep than asset allocation.

That’s unfortunate because this is really important.

At the simplest level it involves how much money you put into shares, bonds and cash. The idea is that spreading your investments across these main asset classes helps protect you when things do badly.

Shares deliver the best returns over time but are at the greatest risk of a big fall; bonds are traditionally less volatile but deliver lower long-term returns; cash is safe but low return.

Below the headline level of asset allocation into shares, bonds and cash, remember to diversify. Sticking all your wealth in one company’s shares, one type of bond and one bank account does not count as successful asset allocation.

To decide on how you should asset allocate you need to consider your attitude to risk, how much you can afford to lose and what period you have to invest over.

There are some general rules of thumb that usually get put forward, typically related to age, goals, tolerance to losing money.

It is well worth spending at least half-an-hour reading up on this, you might want to spend much longer. There are a wealth of studies that suggest asset allocation is more important to long-term returns than picking funds or shares.

At the very least think of asset allocation as a seatbelt – you may not crash but you’re much better off wearing one.

+2

Sage advice: If Warren Buffett likes low-cost tracker funds maybe you should too

4. Invest in the broadest and cheapest tracker fund

The man judged to be the world’s greatest investor, Warren Buffett, says you should avoid trying to pick winners. Instead of trying to find a great share or fund, Buffett argued most people should opt for a simple low-cost index tracker in his annual letter to investors last year.

‘My money, I should add, is where my mouth is,’ he said, before describing the investing instructions left in his will for a trust for his wife.

‘My advice to the trustee could not be more simple: Put 10 per cent of the cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)’

In suggesting this Buffett echoed the words of his mentor Benjamin Graham.  He advocated that most investors should take a passive approach and buy every company in the index.

This makes it impossible to beat the market, yet in reality most share-picking investors and the average professional fund manager will not beat the market either.

Once you try to pick a winner you introduce the chance that you will get things wrong, and either pick a dud or pass up the opportunity to buy something that does very well.

Over time, that counts for a lot and, on average, active investing ends up underperforming.

Taken to its logical conclusion, this theory means that you should try and spread your investments as widely as possible.

Buy just the FTSE 100 and you risk missing out when the UK’s leading index doesn’t do very well but the US stock market does (a brief introduction to that is the Footsie’s performance over the past 15 years in which it only this year regained its December 1999 peak.)

The advent of the low-cost tracker fund has made this kind of investing very easy and very cheap. Vanguard’s LifeStrategy funds invest around the whole world, and can be bought with different percentages of bonds and shares. Their ongoing charges are just 0.24 per cent.

5. If you disagree with step number 4, be more critical of what you choose to back

If I’m going to be entirely honest, the theory in point number 4 doesn’t sound like much fun.

It’s a great easy option and I fully understand why long-term it is probably the sensible course of action.

Yet, I am interested in investing and the world of funds, shares, bonds and markets. This means that I want to look into things that I think will do well and am willing to devote some time and effort to researching them. I am also willing to take on the chin any losses such an approach incurs.

If you are going to be an active investor though, it pays to be very critical of things you choose to back. The investing world thrives on hype and hot properties. The markets are a daily soap opera and there are plenty of characters in it trying to sell you a dream.

There are plenty of active investments made on gut feeling that pay off, but there are an awful lot of bad decisions driven by fear and greed that end up costing people a lot of money.

Don’t mistake luck for investing prowess.

At the very least evaluate investments carefully, question what people tell you and think about how things fit into your strategy and portfolio.

I think value, quality and dividends are the key to long-term returns. But that’s just my personal view, I’d actively encourage anyone reading this to question it.

6. Read more books and considered thinking on investment

One of the pleasures of the internet is that is has put the greatest library the world has ever seen on our desk tops, on our sofas and in our pockets. It has not only never been easier to find interesting things to read online, but it has also never been easier to track down a book.

There are lots of very good books written about investing – more than most people will ever get close to reading. A substantial number of them are entertaining reads. Track down some and read them, absorb the contents and question them.

You may even then want to read the debate online about their merits.

And it’s not just books. One of the interesting aspects of investing that has been drawn out even further by the internet age is investors’ willingness to share ideas.

There’s a lot of get-rich quick nonsense out there and a lot of shameless self-promotion, but also some really interesting, considered and engaging blogs and websites.

It pays to read not just the opinions and thoughts of those you like, but also those that challenge your thinking.

Explore and read some.

And finally…the investing blog post I think everyone should read

The link below is to a post from the Monevator website – one of those very good investing sites that I alluded to above and a regular read of mine.

I read its post after I had planned this article, it covers similar ground and many of our points match. I think the Monevator post is an excellent and thought-provoking piece. I’d strongly advise a read of both it and the comments below it.

-Thisismoney