Introduction to

investing SNAPSHOT SERIES #1

»»

in association with
The Daily Telegraph
Saturday, November 10
 Tom Stevenson, an investment
columnist for The Daily Telegraph,
has been writing about investment for
16 years. A former City editor in the

Contents
national press, he is also an author
and has founded share analysis and
commentary services.

»»
Getting started 4-6

“
Making the most of your money
Complex financial jargon can confuse many means there’s no time to waste
people into inaction but this plain English
guide sets out the fundamental facts you need
to get started. On the rollercoaster 7-9
Tom Stevenson – whose investment How to ride out the ups and
column is a must-read in The Daily Telegraph downs without falling off
Business section each Tuesday – knows that
you do not need to be solemn to make
serious points. Here, he sets out a lively
analysis of the risks and rewards of the main Build a portfolio 10-13
types of asset that individual savers and Why maximising your spread
investors can use to accumulate wealth. helps to minimise your risk
He also explains how delay can prove a
costly mistake and why simple mathematics
strongly suggest that the sooner you Facts and forecasts 14-16
implement a strategy for saving and
investment, the easier it will be to achieve your Take a good look at the past to
financial objectives. make judgements on the future
No single answer will suit everyone because
individual or family circumstances vary so
widely. But this guide should help you Theory and practice 17-19
consider your options – perhaps in discussion
Bulls, bears and trying to be in
with a professional financial adviser – and
the right place at the right time

”
reach informed decisions to help you make
the most of the opportunities available today.

Ian Cowie, personal finance editor Pooled funds 20-23

The Daily Telgraph Who runs them, who invests
and whether they’re a good buy

PICTURES: ALAMY, DANIEL JONES, GETTY, PHOTOLIBRARY.COM Barclays Snapshot series 3

Getting started
I
nvesting intelligently, with enough, shelter their savings from your bid for a secure future is
a sensible plan and from tax efficiently or work to minimise time. Healthier lifestyles and
a young enough age, can the terrible toll that inflation can take medical advances mean that most
make you seriously wealthy. on the real value of their assets. of us will have more of that than
Not just in terms of money The slow but inevitable death of our parents. More time to secure
but in the most important the private sector final salary and enjoy our finances or more
things that money can buy – pension scheme has made it more time to rue our failure to do so. It’s
the time and freedom to live urgent than ever that we and, more our choice.
life on your terms. importantly, our children learn how
to be intelligent investors. There’s no The magic of
Most people do not realise that with greater gift for your offspring than compounding
a little application, discipline and an financial competence and
early enough start, they can secure confidence and there’s no better Getting rich slowly and inexorably is
financial freedom for themselves time to start gaining it than today. not complicated. It can be achieved
and their family. It is hard to think There are no short cuts to simply by harnessing the financial
of a more attractive goal, but most financial freedom, no get-rich-quick world’s best-kept secret – the
people will not achieve it. schemes on which to rely. The good almost magical power of
The majority face a future of news is that you do not need any. compounding.
relative poverty because they do not Focus instead on the steady, Albert Einstein called
understand how to harness property relentless accumulation of real compounding the eighth wonder
and financial assets such as shares wealth through intelligent of the world. He was right.
and investment funds to accumulate investment. That may sound Compounding is a profoundly
significant wealth, slowly and surely mundane but it has the merit of powerful force and used with skill
over time. being both realistic and achievable. and patience it will give you and
They do not start saving early The most important element in your family the warm glow of

4 Barclays Snapshot series


financial security for the remainder
18-year-old sisters – let’s call them
of your lives. Prudence and Extravaganza.
It is a simple concept. If you Prudence, for whom the
increase a sum of money by the compounding penny has dropped
same percentage amount each unusually young, starts saving
year, the monetary value of each £1,000 a year – that’s just £20
annual increase gets a week – when she leaves school,
progressively larger. Grow investing it intelligently for a
£1,000 by 10pc and the first consistent return of 10pc a year
year’s increase is £100. The (let’s not worry for now how she
following year, however, the same does that or whether the 10pc
10pc rise is worth £110. annual return is realistic).
Apply the same growth rate for 20 After 20 years, the £1,000 she
years and the 10pc rise in the final
saved in the first year has grown
year will be worth more than £600 to £6,700, a nice return but only
– six times the first year’s increase.
a part of the story because, in each of
the following 19 years, clever
A tale of two sisters Prudence put aside another £1,000.
The second year’s savings have
To understand thoroughly the power grown in 19 years to £6,100, the
of compounding and the third year’s to £5,600 and so on.
importance time plays in its In 20 years, by the age of just 38,
magic, consider the story of twin Prudence has amassed £57,000
by putting aside
£20 a week.
By this time,
her problems
are basically
over
Getting started
»»
because now the amount she is
earning from her savings is already
vastly in excess of the money she is
putting aside. At 40, when most
people are starting to think about
saving, she can stop if she chooses
By the time she is 50 her savings
will be growing at £18,000 a year
and by her 60th birthday she will
have more than £500,000, not bad
for a £20-a-week savings plan to
which she hasn’t even contributed
for the past 20 years.
Now let’s look at Extravaganza
who, like most of us, finds 101
other things to do with her money
until, on her 38th birthday, she
panics. She realises that she has
nothing to show for the £20 a week
she has spent without even noticing.
Belatedly she, too, starts saving
£1,000 a year in the hope that she
will catch up with her sister. She
never will.
By the time Extravaganza is 60,
despite saving for a couple of years
more than her sister, she will have
amassed just £79,000, around a
sixth as much as Prudence.
If we could tell our children only
one story, this would be high on
the shortlist.
Barclays Snapshot series 5
 Getting started
Compounding
and property
You’ve probably already
experienced the power of
compounding. If either you or your
parents bought a house 30 years
ago, you might have paid as little
as £10,000 for it. Today the same
house is probably worth £250,000
or, in some parts of the country,
considerably more.
That massive rise has been
achieved because in almost every
year since the house was bought,
house prices have risen by a small
but significant percentage. Each
year that percentage gain was
applied to a larger starting figure
until the value of the house grew
to a level that would have been
scarcely imaginable at the outset.
It is entirely possible that house
prices, which have reached very
high levels by historic standards
of affordability, will not produce
anything like these kinds of gains
in future years. But that argument
could have been made at many
times in recent times. Betting
against the property market
6 Barclays Snapshot series
would have been a very expensive
mistake.
The property market has the odds
stacked in its favour in this country.
As Mark Twain famously quipped:
they don’t make land any more.
One of the reasons why the US
housing market is in such a mess
today is that America does not have
the same space problems and
consequent planning constraints
as Britain does. They can, and do,
build more houses than they need.
We have the opposite problem.
Property also benefits from
increasing wealth because as
people grow richer they are able
to spend more of their income on
housing while still increasing their
standard of living. This is one reason
why house prices have tended to
grow faster than average earnings
over time and why I would not want
to bet against property remaining an
excellent investment despite today’s
apparently frothy prices.
The Rule of 72
A useful rule of thumb for
measuring the power of
»»
compounding and for understanding
the importance of starting to invest
early in life is the Rule of 72.
This simple guide shows how long
it takes to double an amount of
money at any given rate of interest.
To use it, simply divide the growth
rate you expect to achieve into 72.
In this way you can see that a 12pc
rate of growth will double the
amount you start out with in six
years. A 4pc rate of growth will
mean it takes 18 years to achieve
the same result.
Assuming the 10pc growth which
Prudence and Extravaganza
achieved – not a million miles away
from the returns on property and
the stock market over the years, by
the way, although past growth is not
an indicator of future performance –
it would take around seven years to
double your money.
This is why it is so important not
to delay. If you’ve £10,000 to start
with and 21 years to get to work
with it, you might hope to end up
with £80,000. But if you’ve 35
years to play with, you’ll be looking
at £320,000 by the time you need
the money. What a difference.

Riding the rollercoaster
of investment
T
he differing performances
of the housing and stock
markets over the past
decade – the first has risen
steadily while the second has
been volatile and risen little
in total – provides a strong
argument for not putting all
your eggs in one basket.
Diversification is an important
feature of any intelligent
approach to investment, as
many investors found
to their cost in the
years after 2000.
They were
dangerously
exposed to that
year’s hot
investment asset –
technology shares –
and paid the price when it turned
into the subsequent bear market’s
worst performer.
A balanced portfolio of property,
domestic and overseas shares
together with a range of other
assets such as bonds, gold
and commmodities would
Riding the
rollercoaster
»»
have prevented much of the
suffering in the early years of
the decade.
While the stock market was losing
half of its value in the three years to
March 2003, property benefited
from a sharp reduction in interest
rates (some would say too sharp),
which reduced the cost of financing
a house purchase and so fuelled a
rapid escalation in values.
Meanwhile, rapid
industrialisation in
China and India
quickly altered the
balance between the
supply and demand
for commodities of all
kinds. The prices of oil,
metals and more recently
agricultural commodities have
soared as a result.
Barclays Snapshot series 7
 no one can realistically do that on a man who went to sleep one night
diminish risk with £10,000 invested in shares.
a consistent basis. The first rule of
Like Sleeping Beauty, he stayed
intelligent investing is to live to fight
Even within the stock market, investors another day. The only certain way ofasleep for 100 years and, on
shun a well-spread portfolio at their not getting wiped out is to ensure waking, called his broker to see how
peril. The power of diversification his portfolio was doing.
that you spread your risks prudently.
was brilliantly illustrated by His broker was long dead, of
Professors Elroy Dimson and Paul Beware the investor’s course, but his grandson told the
Marsh of the London Business enemy number one man his shares were now worth
School in this year’s Global £10m. Overjoyed, he rushed out to
Investment Returns Yearbook, a buy a newspaper to read about the
study they conduct annually for Compounding is a wonderful thing events that had caused this massive
ABN Amro, the Dutch bank. for an investor as we have seen, but rise in his net worth. When he was
In it, they showed that an investor it is a two-edged sword. Sadly, the asked for £250 for the paper, he
who had placed £100 in the deeply same force which will relentlessly was understandably less happy.
unfashionable tobacco sector in increase the value of your Inflation is not the monster it was
March 2000 would have ended up investments is also working on the in the Seventies, when the cost of

The first rule of intelligent investing is to live to fight

another day. The only certain way of not getting wiped
out is to ensure that you spread your risks prudently

with £767 six years later, while one
who had put the same amount into
the then red-hot technology
hardware sector would have ended
up with just £6.
Putting all your eggs in one basket
is great if you pick the right one but
8 Barclays Snapshot series
cost of living. Even a modest rate of
inflation, compounded year after
year, can drastically reduce the
purchasing power of the money you
have saved. You will have to run
pretty fast just to stand still.
There’s a sobering City joke about
living rose three-fold in just 10
years. According to Barclays Capital,
we have not endured double-digit
inflation since 1981. Since 1996,
prices have grown by 2.8pc a year,
on average.
Even at that modest inflation rate,
 Riding the
rollercoaster

»»
however, prices have more than she doubles her money in seven Generous Individual Savings
doubled in 20 years. Over an years. At 6pc a year it takes her 12. Account (ISA) and personal pension
investor’s lifetime quite a lot of the In 35 years she will double her tax allowances mean that most
nominal growth in the value of his money five times with a 10pc return people can shelter all of their
assets is an illusion – it is what’s but three times at 6pc. Put another savings from tax. They don’t even
required just to keep in the running. way, £10,000 will grow to have to tell the taxman about them
£320,000 at 10pc but just on their tax return.
Beware the investor’s £80,000 at 6pc. Thank you, Everyone should put as much
enemy number two Mr Chancellor. as they can afford into these
– tax Fortunately, and it is not often we tax-efficient vehicles every single
can say this, the UK tax system is year. You can’t go
Another little-understood aspect of currently structured in a way that back and use them
compounding is that it magnifies means most people once the moment
massively the impact of what might need never worry has passed.
initially seem to be an about this drastic
inconsequential difference in impost.
performance.
To return to sensible Prudence,
imagine that the 10pc annual
returns she generates over her
successful investing life are taxed as
she makes them at a rate of 40pc.
For every £1 of investment return
she achieves, she passes 40p on to
Mr Darling in the Treasury.
In the short-run that is an
irritant but in the longer-term
it will have a catastrophic
impact on Prudence’s
returns. Remember,
at 10pc a year
Barclays Snapshot series 9
Building a
portfolio
S
o we know we should credit crunches and sub-prime shares, bonds, property, cash and
invest, we know we crises, savers and investors have pooled investment funds will
need to get going as started worrying about things they continue to serve our purposes.
soon as we can and we know never even knew existed. Throw in commodities and gold
we should not put all our eggs No one should pretend that the and you have more than covered
in one basket. But what are turmoil in the world’s financial the waterfront.
those baskets, which should markets this summer is not a real
we choose and how much problem. The fear and uncertainty Risk and reward
should we put in each? it has created has thrown grit in
the machinery of the world’s bonds, shares,
If you’ve shown even a passing financial system, and that is likely property and
interest in the business pages this to slow investment and growth commodities
summer you may have come away in the future.
with the impression that the financial The greatest damage that the The main thing to understand about
world is complex, incomprehensible turbulence could cause, however, all these assets is that they offer the
and dangerous. Even the experts would be if it were to undermine our prospect of different levels of reward
have found themselves battling to faith in saving and investing for the for different levels of risk. There are
understand an alphabet soup of future. Most of us can leave no more free lunches in investment
previously unheard-of financial complex derivatives to the whiz kids than in any other walk of life, so if
products such as CDOs, CLOs and running hedge funds in Mayfair and you are attracted by the thought of
ABSs. With lurid headlines about Connecticut. A portfolio built around bigger returns you must accept the
10 Barclays Snapshot series

possibility that you will make bigger
losses along the way.
The least risky asset of all is cash.
There are only two threats to a cash
investment – someone stealing it or
inflation nibbling away at its buying
power. Because risks are low, the
returns usually are too, although in
today’s volatile markets many
investors will consider a
high-interest bank
account offering 6pc
a year or more to be
an attractive
proposition.
Sometimes cash is a
good place to be and
any portfolio will want liquid
funds to take advantage of
opportunities in other
assets.
Running cash a close
second in terms
of security are bonds, especially the
ones sold by governments in stable
countries such as the UK.
Government securities, or gilts as
they are known here, offer a fixed
annual income and more or less
guarantee repayment of the sum
initially invested. They also offer the
possibility of capital gains (or losses)
because their value rises
and falls according to
movements in interest
rates. The best time to
buy bonds is when
interest rates are high
and falling.
Shares are more risky
than bonds because there is
no guarantee that you will get
back the amount you invested.
That is why they are termed
risk capital. When you buy a
Building a portfolio
»»
share you take part-ownership in a
company and you share in its
fortunes thereafter, both good and
bad. Investors are prepared to
shoulder the increased risk of
shares because, as an owner of the
underlying business, they participate
directly in the rising value of a
successful company and receive
their share of its growing earnings in
the form of a rising dividend.
Like shares, property is a real
asset. Its value can rise and fall and
so, too, can the income stream it
generates. Both property and shares
can help an investor reduce the risk
posed by inflation because the rents
charged by the owner of a building
and the prices charged by a
company are able to rise in line with
the cost of living.
Commodities, such as industrial
metals and agricultural crops, also
offer a link to rising prices but their
prices can be very volatile. In part
this reflects the fact that, like gold,
they offer no income. Their price is
a simple reflection of the fluctuating
balance between supply and
demand, not to mention the
influence of speculators.
Barclays Snapshot series 11
Historical facts
and forecasts
 Historical facts
and forecasts

»»

W
henever you see
a financial product
advertised you will
always see a warning along
the lines that past
performance is not a guide to
the future. This is, of course,
technically true but it does not
mean that we cannot learn
something meaningful from
what has happened to
different asset classes over
the years.

Barclays Capital produces a

fantastic guide to this performance
each year in its Equity Gilt Study.
The most recent edition shows that
in the very long term, shares have
been far and away the best
investment.
After adjusting for the impact of
inflation, shares have produced a
real return of 5.3pc a year over the
past 107 years (since the survey’s
start date in 1899), while
government securities (gilts) have
beaten the cost of living by 1.1pc
and cash deposits have produced a
real return of 1pc.
Over shorter periods, shares have
Barclays Snapshot series 13
also beaten the other main asset
classes, although by a more
narrow margin.
Over 20 years, for example,
shares have been seen to give an
inflation-adjusted return of 6.9pc
compared with 5.6pc for gilts
and 3.7pc for cash. Over
10 years, shares have returned
4.9pc, gilts 4.6pc and cash
2.6pc a year.
One of the explanations for the
higher returns offered by shares is
Medium to long-term terms. That’s pretty much the same
investment range as for gilts and only a little
probabilities wider than for cash. So even over
quite short periods, higher returns
If you had held shares for just one have been on offer for little extra risk
of the past 107 years, for example, to investors in shares.
you might have doubled your Push the investment horizon out
money or lost almost 60pc of it further and the odds are stacked
over the 12-month period. An even more favourably towards
investor in gilts, by contrast, would equity investment. By the time you
never have made more than 60pc get to a 23-year holding period,
in any 12-month period but would there has never been an example of
also never have lost more than shares losing money in real terms.

The longer an investor stays in shares, the lower the risk

becomes. The probability of shares outperforming cash
rises to more than 90pc if you hold them for 10 years

the greater risk that an investor
might lose money. But an interesting
point emerges from the Barclays
study – the longer an investor is
prepared to stay in shares, the lower
the risk becomes.
For such long-term investors,
shares have historically offered
not only higher returns but
lower risk.
14 Barclays Snapshot series
about 30pc of his initial investment
after accounting for inflation. Cash
has been even less volatile.
However, if you hold your
investments for at least five years,
the picture changes dramatically. In
no five-year period during the past
century or so have shares returned
more than 20pc a year nor lost
more than 20pc in inflation-adjusted
That is not the case for either gilts
or cash. In as much as any
investment asset has been able to
offer a rock-solid guarantee, it has
been shares, not supposedly safer
government securities or cash.
Indeed the probability of shares
outperforming cash rises to more
than 90pc if you are prepared to
hold them for 10 years or more.

Hold them for 18 years and you are
almost certain (99pc) to beat cash
on the basis of the historical record.
Equities have beaten gilts over 10
years 83pc of the time and over
18 years 91pc of the time.
Who’s in, who’s out?
The Barclays Capital study is, of
course, an academic exercise.
In the real world, no-one
simply buys the market, let
alone holds it for 107
years! They buy more
focused investments and
in doing so they,
consciously or not, make a
judgement about the relative
performance of their
chosen asset compared with all
the other possible investments they
could make.
At any one time, in rising as well
as falling markets, some assets are
doing better than others. We have
already seen that it would have
been possible to avoid the worst
of the 2000-2003 slump by
weighting your portfolio more to
Historical facts
and forecasts
»»
property or commodities and less to 100 index of Britain’s biggest
technology stocks. shares had doubled before suffering
Similarly, there are times when setbacks at the time of writing and
large shares do better than smaller the FTSE 250 of medium-sized
ones and vice versa. In the final companies did even better in the
years of the great Nineties bull upswing. Some experts claim that
this extended period of
outperformance may now reverse,
especially if the corporate takeover
boom, which has tended to focus
on mid-cap stocks, slows
down.
When the economy
is firing on all cylinders.
investors often favour
shares in companies that
are particularly affected
by the economic cycle –
industrial companies or
retailers, for example.
During a slowdown or
recession, they tend to look for
safer havens and companies
that enjoy steady demand for
market, the best performing shares their products in all economic
were the very biggest but since then environments have their day –
smaller companies have pharmaceutical and utility
outperformed dramatically. Since stocks tend to be defensive
the recovery in the market began in investments in these more
March 2003, for example, the FTSE difficult periods.
Barclays Snapshot series 15
Putting theory
into practice
M
arkets are inherently
unpredictable and
even experienced
investors have difficulty
spotting the best times to be in
or out. Even the best investors,
such as Fidelity’s Anthony
Bolton, have endured periods
when they have got it wrong.
Because of this, investors
should not worry too much
about the short-term ups and
downs of markets. Over time,
markets have tended to rise
because they reflect the
growing wealth of the world
and it would be surprising if
this were not to continue.
16 Barclays Snapshot series
Along the way, however, there will
undoubtedly be some nasty air
pockets which will leave us feeling
distinctly queasy. An investor who
can, at the very least, take his foot
off the pedal when markets are
turning down and increase his
exposure when they rise again will
be much more successful in the
long run.
So how to spot when the market
is coming to the end of a bullish
or bearish phase? Here are a
few pointers.
Classic signs that a bear market
might be on the way include the
following: cash is considered a very
undesirable asset, interest rates may
be low and about to rise, most
investment advisers will be
enthusiastic and the general mood
will be upbeat, there will be lots of
new issues or companies floating
on the stock market, few directors
will be buying shares in their own
companies, everyone will be talking
about investment and it will have
a high profile in the media.
Conversely, bull markets tend to
start when few of the above apply.
When everyone is looking for the
safety of cash, valuations are at
historic lows and no-one is
interested in stocks and shares,
the shrewd investor will move in
for the kill.
 Putting theory
into practice

»»

Expert Advice decisions to be taken about timing, It makes to consult fully authorised
asset allocation and the selection advisers representing financial
Deciding to become an investor is, of individual investments. A good institutions with valuable
of course, just the first step. As we adviser will help you with these reputations they must protect,
have seen, there are countless crucial questions. and never to be afraid of
Barclays Snapshot series 17
asking questions. Beware of jargon
you do not understand and insist on
answers in plain English.
The first question, mentioned at
the start of this guide, is possibly the
hardest, however: what kind of an
helpfully in your favour. Most of your
investments will be in shares with
a proportion in cash to take
advantage of the dips in the market.
If you also own your house or flat
you will have already acquired
or even decades changes the
arithmetic of asset allocation. If
you live for 30 years after you stop
earning, a major consideration
should be maintaining the inflation-
adjusted value of your savings and

The probability that people will live in retirement for

many years changes the arithmetic of asset allocation.
You should be maintaining the value of your savings

investor am I? How long have I got an exposure to the property market not simply maximising the income
to invest? How prepared am I to – in fact you are likely to be from them.
lose money? How much do I want over-exposed to it relative to your
to be involved in the process or am other assets. Being in the
I more interested in getting on with There is a rule of thumb among right place
the rest of my life? investment advisers that your
portfolio should include a Asset allocation is crucially
Getting the right mix percentage weighting in bonds that important. Indeed a study
matches your age. So a young conducted in the early Nineties,
The answers you give to these investor might have a fifth of their Determinants Of Portfolio
questions will help to determine how investments in fixed-income Performance, concluded that 90pc
you divide your investments. If you securities and someone close to of the variation in institutional
are just starting out, like Prudence – retirement more than half. investment returns is caused by
mentioned in chapter one – you Some would consider this overly asset allocation and less than 10pc
may want to maximise your cautious and there is no doubt that by market timing or stock selection.
exposure to the asset which we the increasing probability that people Size and style of investments
have seen stacks the odds most will live in retirement for many years matter greatly. ABN Amro has
18 Barclays Snapshot series

found, for example, that small cap
shares have outperformed big
stocks by more than 6pc a year
since 2000, a massive difference
when compounded year after year.
Geography is a major factor too. In
2006, the Chinese stock market
recorded a 117pc rise while Japan
edged ahead by just 3pc. Russia
rose by 58pc while the US grew
by just 16pc.
Being in the right place at the right
time has been a feature of the
market for many years. AC Financial,
an independent adviser, has
calculated that £1,000 rolled over
Putting theory
into practice
»»
each year into the best performing
sector in each of the past 25 years
would have grown to £234,000,
while the same £1,000 in each
year’s worst performer would have
shrunk to £267. The first is a 24pc
rise per year while the second is
a 5pc a year average loss.
Different types of
pooled funds
C
hoice is a virtue but, intriguing book called The Little only the total gain of the market
with more than 2,000 Book Of Common Sense Investing minus the costs of investing –
unit trusts and in which he makes a compelling management fees, brokerage, sales
open-ended investment case for abandoning the attempt to commissions, advertising and so on.
companies (OEICs) plus beat the market and simply These can add up to 2.5
investment trusts available in participating in the relentless growth percentage points of a fund’s
the United Kingdom, investors in the world’s economy by buying performance each year while a
could be forgiven for reflecting a low-cost index tracking fund. tracker fund can operate at maybe
that it’s possible to have too These funds simply buy every 0.2pc a year. This might not sound
much of a good thing. stock in a given index and never much of a difference but the rules of
attempt to make a judgement about compounding turn it into a colossal
The fact that performance varies which will do better or worse than difference over any extended
wildly between the best and worst any other. This simple approach period.
fund sectors, styles or geographies means they can invest relatively Bogle’s second argument is that,
is not necessarily an argument for cheaply and pass on the benefit human nature being what it is, we
trying actively to choose the winners to investors. cannot hope to capture even the
and avoid the losers. The essence of Bogle’s claim is market’s total return because
John Bogle, the founder of the that investing is a zero-sum game. invariably we buy the wrong sort of
successful Vanguard fund One investor’s gain is another’s loss funds at the wrong time. American
management group, has written an so investors as a whole can capture investors put $18bn into equity

20 Barclays Snapshot series


funds in 1990 when stocks were
dirt cheap and a combined total of
$420bn in 1999 and 2000 when
they were patently expensive.
Where’s the fun
in that?
Bogle’s argument is ultimately rather
dispiriting, however. It suggests that
the only sensible thing to do is to
save regularly in a tracker fund and
stop kidding yourself that you can
beat the market. With the FTSE 100
trading at little more than it did 10
years ago, and still below the peak it
reached in 2000, his approach
seems actually to be rather risky.
More sensible – and fun – would
be an investment strategy based on
concentric circles. At the heart of the
portfolio would be long-term core
holdings including the investor’s
house and some index trackers.
Moving outwards, the holdings
would start to include a range of
pooled investments (unit trusts,
OEICs and investment trusts)
diversified across styles (large
companies and small, growth
stocks and value investments),
geographies, sectors and fund
managers.
This is where investors are able to
back their big-picture judgements.
They may decide, like investment
bank Goldman Sachs, for example,
that the most important economic
development of the next 20 or 30
years is the unfolding growth in
developing countries such as Brazil
Russia, India and China – the
so-called BRIC countries.
They may decide that the strains
of feeding, clothing, heating, housing
and transporting a larger developed
world will put upward pressure on
the prices of raw materials such as
oil, metals and crops and invest in
funds that reflect that call.
They may decide that the only
thing that really matters, looking
forward, is climate change, so they’ll
put money in companies investing
in sources of alternative energy.
Finally, more active investors might
decide to back their own judgement
with a relatively small proportion
of their portfolio invested in
individual shares.
Different types of
pooled funds
»»
Pooled investments
Most investors will not feel
comfortable pushing out into this
outer layer of investment in which
they make decisions about
individual assets, whether that is
a company share, a bond or
investment in an individual
commodity – copper, say, or corn.
Even if they understand that in the
long run the stock market is not
more risky than other savings
vehicles, they prefer to shelter within
the perceived safe haven of a
managed fund, prepared to pay
a fund manager to make the
investment decisions and to
benefit from the diversification of
risk within a portfolio of 100 or
more individual investments.
For many people, this more
cautious approach is entirely
appropriate. If you have neither the
time nor inclination to learn more
about investment, you should stick
to tracker funds or a spread of
actively managed funds. As we have
seen, financial security can be
achieved if you start early enough,
Barclays Snapshot series 21
by the steady accumulation of
relatively unambitious yearly returns.
But it is important that people who
do this understand that they are
taking risks nonetheless. The first is
that excessive diversification dilutes
the potential gains available. If a fund that have a track record of success.
holds 100 stocks of equal value, for
example, a doubling in the value of
one investment will increase the
value of the whole portfolio by just
1pc. In a more focused portfolio of
10 shares, the same doubling
would increase the value of the
portfolio by 10pc.
Another point to bear in mind is
that a fund manager with a portfolio
of 100 stocks probably knows
some investments very well and
others little or not at all. He insures
against his lack of knowledge with
a wide spread of investments but
there is a price for the buyer to pay.
Method in their
madness
Investors who do decide to push
out into this outer layer of higher-risk common-sense investing.
but potentially higher return
individual investments will find that
22 Barclays Snapshot series
they have entered a whole new
world. They will have to learn how
to value a share on the basis of its
earnings, dividend yield or assets.
They will also want to explore
different share selection methods
Over the years there have been
plenty of “magic” stock-picking
formulas. They are a staple of the
investment book publishing machine
and to the wishful-thinking investor
looking for profits without pain they
can seem like the holy grail.
Unfortunately, like unit trusts
marketed on the back of a stunning
five-year performance, they can
sometimes gain currency just as
they lose their edge.
For the intelligent investor, they
can, however, provide an excellent
starting point in the selection
process. For example, growth stock
investing as popularised by Jim
Slater through a series of books,
including the best-selling Zulu
Principle, is a simple statement of
In essence the Slater approach is
to find shares which offer maximum
earnings growth for the lowest
possible price. The method is
sometimes known as Growth At A
Reasonable Price or GARP for
short. It looks for shares where the
most commonly used valuation
measure – the multiple of earnings
at which a share price trades – is
low when compared with the
expected growth in profits.
Another widely used method
focuses on dividends, looking for
the companies which offer the
highest dividend income when
measured as a percentage of the
share price. Companies like this,
with a high dividend yield, often
perform relatively well because
investors are attracted to the high
income and bid up the price when
they buy the shares to secure it. The
most famous exponent of this
high-yield investment approach was
an American fund manager called
Michael O’Higgins, who popularised
the method in a
best-selling book Beating The Dow.
There are plenty of other share
selection methods that have worked
over the years. Some investors buy

on momentum. They watch for
shares that have begun a rising
trend and jump on the bandwagon
until the outperformance starts to
flag. The opposite technique is to
buy the most out-of-favour shares
in the market, a contrarian approach
that hopes to profit from the market
tendency always to over-react to
both good and bad news.
Five steps to
intelligent investing
Intelligent investing is really
just stacking the odds in
your favour. Here are five
ways to do this:
1 Have a margin of safety
The key to successful investing is
to establish a margin of safety. The
best way is to invest with a method.
You might change your method
according to the state of the market
or prevailing investment trends but
it is vital that when you make an
investment you know why you are
doing it. Mechanical screening
methods such as those used by
Different types of
pooled funds
»»
Slater and O’Higgins have the merit a loss. History shows that getting out
of taking sentiment out of the of mistakes early and riding the
selection process. Sometimes an winners is the way to success.
investor’s biggest enemy is the face
he or she sees in the mirror. 4 Don’t be fooled by Mr Market
Benjamin Graham, a legendary
2 Stick with it – save regularly American investor, said you should
No-one can predict the future path view the market as you would a
of the stock market but logic and neurotic business partner. On some
past performance suggest the days your partner is on top of the
long-term trend is upwards. world and offers you a high price to
The trend, as they say, is your buy out your share of the business.
friend. In the past 30 years, the UK On others he is depressed and will
stock market has ended the year take a low price for his own share.
lower than it started on just five The key point is that, except in a
occasions, in 1990, 1994, 2000, very minor way, the underlying value
2001 and 2002. If you look at a of the business does not change
long-term chart of the stock market, while he is making these fluctuating
the legendary crashes of 1929, offers. You should seek to buy the
1987 and even the savage bear market when it is most downbeat
markets of 1973/4 and 2000- and to look to offload your shares
2003 are barely perceptible blips. when it is most optimistic. This is
difficult but essential.
3 Cut losses and run profits
One of the hardest things in 5 Start today
investment is knowing when to sell. The key to investment success and
It can be hard to hold on to an the financial security it can bring is
investment that has doubled or not asset allocation, share selection
trebled in value and just as difficult or a knowledge of high finance, but
to acknowledge a mistake and cut time. Don’t let it slip away.
Barclays Snapshot series 23