This post may contain affiliate links which means that if you click through to a product or service and then buy it, I receive a small commission. There is no additional charge to you.
Please be aware that the value of any form of stock market investment can go up and down over time, and your initial investment is at risk. You may want to consider advice from a qualified financial adviser before investing.
Those of you who read The Times may have seen a rather large photo of me in last Saturday’s edition. I was a case study, talking about being invested in the Woodford Equity Income Fund, which is currently suspended. The headline for my case study reads:
‘There’s no point realising a loss. I’m not worried’
‘I’m not worried’ sits in contrast to the majority of case studies which have featured in the wider press over the last week who are furious at the suspension, which is why I was featured.
Sure, the inability to access my money – they are saying the fund could be closed until Christmas – doesn’t sit particularly well with me; it’s my money after all. The fact too that I am still being charged fund management fees grates…
I definitely have concerns that when the fund reopens, there will be a rush of redemptions which could further impact the fund. That could be a significant issue.
There are a lot of investors who invested in the fund because of the marketing of it’s launch or what they’d read about Woodford’s previous track record, rather than any affiliation with his investing choices and recently, his thoughts on how Brexit was impacting the value of UK stocks. The media hype about this unusual suspension will undoubtedly mean that many of them bail out at a loss when it reopens. The old problem of fear of further falls and herd mentality in investing decision making… [sigh]
HOWEVER, the bulk of the interview I gave focused on WHY I am not up in arms as much as the next person and why I am OK with sitting tight on my paper loss at the moment, subject to keeping up with what’s going on.
And it all comes down to the way in which I diversify my portfolio. Which is what I want to talk about today.
So what do we mean by diversification when we are talking about investing? Well put simply, it’s about not having all your eggs in one basket.
There are various different asset classes available to an investor who wants to hold an asset with a view to generating either capital growth, ongoing income or both:
- Cash or cash equivalents
Most financial experts agree that the most effective investment strategies involve diversifying investments across categories.
The reason why? It reduces risk.
Note that diversification in itself doesn’t protect you against losses but by having a broad mix of assets in your overall portfolio, any loss in one area of your investment mix can be offset by gains elsewhere.
You’ll find examples of people who invest in only specific niches who have hit the jackpot and are uber rich. But for the average person, diversification helps us sleep peacefully at night!
Classes within classes
Within the broad asset classes above, there are sub-set of these. If we think about exposure to equities, you can invest in:
- Shares of specific companies
- Funds (which hold investments in lots of companies) which focus on particular geographies
- Funds which focus on a particular size of companies; smaller being more risky
- Funds which focus on particular industries eg technology
You can even get funds which focus on particular size of companies in particular geographies… eg UK small cap companies.
With property, you could invest in residential property or commercial property directly. You don’t even need to own the property itself; you can invest in indirect property funds that focus on the shares of firms within the property and building sector.
You see where I am going here…. The options are broad.
So why is diversification important?
Selecting a diversified mix of investments means you are not exposing yourself too significantly to volatility – the ups and downs – in any one area.
The bulk of my share portfolio is invested in multi-asset, globally diversified funds.
Multi-asset means they hold a mix of shares, bonds and cash. Globally diversified means – well, you can’t get any more diverse than the world can you?
I haven’t always invested this way; I started my investing journey years ago investing in individual shares. At the time, I was happy with a higher level of risk for the potential for higher returns.
In 2009 I bought a tiny mining stock which rose 2000% in 2 days. The greedy part of me didn’t cash it all out; I wanted more growth. That very same stock still sits in my broker account worth 90% less than I paid for it. A reminder to me of the risks of investing in individual stocks.
As I have got older, I have opted for less risk.
Also, my personal experience of investing in both passive funds (those that aim to track the performance of the underlying market) and active funds (which aim to outperform the market but for which you pay a higher fee), confirms to me what a lot of the evidence available points to: active investing doesn’t outperform!
The rest of my share portfolio – under 20% – is invested in funds which have a narrower focus. None of these investments individually represents more than about 3% of my total portfolio.
I think of my core portfolio as a planet with 10-12 much smaller moons as satellites. These moons might come and go as my interest in a particular sector eg tech, come and go, but the core multi-asset, globally diversified planet is a constant.
Pete Matthew explains this concept brilliantly in one of the episodes of his podcast – Meaningful Money. Do give it a listen!
So, back to Woodford. I am invested in the Woodford Equity Income Fund; it’s one of my satellites allowing me exposure to the UK. This particular satellite is worth about 2.5% of my portfolio by cost. It’s also my only fund in the red. Which means that 97.5% of my portfolio is up.
Factor in that we also have rental property which further diversifies our investments and you can see the real story behind my case study in The Times.
If the very worst came to fruition and I lost my whole investment in the fund (this is always a risk with investing but very unlikely here unless every single company in which the fund is invested goes bankrupt!), the relative impact TO ME is minimised because of the weight of this particular investment in my overall portfolio.
My plea to investors
The investment platforms did a great job of marketing Neil Woodford as a ‘star’ fund manager when the fund was opened and ongoing. Indeed, Hargreaves Lansdown has come in for a lot of criticism for continuing to promote the fund on its Wealth 50 list right up until its suspension.
There are evidently significant numbers of people who invested in the fund based on this.
But I am shocked by the case studies of Woodford investors who have a large proportion if not all of their portfolio in this fund. Whilst it is of no comfort to these people, this debacle has highlighted the importance of diversifying the funds in your portfolio. Yes, even if you are invested in a fund which itself invests in multiple companies.
My second plea is around what’s going to happen when it re-opens. There will undoubtedly be those who rush to offload their investment; those who are fearful of further falls. This, in my opinion media-induced, herd mentality does mean further risk for the fund as more money is required to fulfill redemptions, necessitating further sales. Do reflect on your rationale for investing with Woodford in the first place and whether you are aligned with his investing strategy before you act. Do not act purely on emotion.
I think I shall have to do a further article on behavioural finance and why emotions shouldn’t play a part in your investing plan. One for another time…
I’ve talked about passive and active investing in this article. There are some who say that active investing has no place at all, that it is cheaper and no less rewarding to just track the market. The performance of the Woodford Equity Income Fund here IS a case in point.
Anyway, as a follow up, I will shortly do another article on active vs passive investing, explaining the differences.