Once you’ve chosen your investment vehicle, there are four core elements you can invest in (shares, managed funds, trackers or bonds), which I’ll outline below and highlight some of the benefits and costs of each. They apply equally to pensions and ISAs, the difference being the limits of what you can put in, when you can take them out and how they’re taxed.
Shares, stocks or equities
These represent small portions (shareholdings) of an individual company. Take, for example, the drinks company Diageo. Ownership is split into approximately 2.56 million shares and at the time of writing each one was worth around £3.26. You can buy any number of shares in your pension or ISA. There’s a small difference in the buying and selling price of the share to cover trading costs but you’re free to buy any publicly traded share in the UK or overseas. Shares are traded on the stock market, which goes up or down in value depending on trading conditions, press releases or the company’s general health and outlook. You buy shares in the belief that the company is well run and growing and therefore the share price will rise, or that the company will pay a dividend to shareholders. In essence, dividends are the excess profit the company has made in a year and they’re usually paid back to shareholders, expressed as a percentage of the share price. It’s referred to as the ‘dividend yield’ and as I write, Diageo sits at 2.45%.
Buying shares can be a profitable endeavour but it’s a risky business as you’re betting on a single company and there are many unforeseen factors that can challenge it, however big or established the organisation. There’s also the question of timing the sale of the shares, as that’s when you get your money back. You either pick a share that’s increasing in value and ensure that you sell before it drops off, or you invest in a company that has a reliable dividend yield. Ideally, you want both but there are fewer unicorns around and if you do see one, it’s not likely to remain favourable in the long term. Individual shares aren’t really suitable for the novice investor. However, many platforms allow you to build a virtual portfolio of shares and track how your stock picking would have fared. Unless you’re confident with your investments, leave individual shares to others and don’t be tempted by ‘hot tips’ from any number of sources just because you’ve read that a particular company is undervalued and set to double in size over the next year. I’ve held a fair number of shares over the years but there have been just as many that have gone nowhere as those that have done spectacularly well (my Tesla holding increased tenfold). So, while I consider myself to be a successful investor by virtue of my current financial position, I’m no expert. What I’ve learned is to spread the risk.
Funds
Rather than taking a punt on an individual company, a safer alternative is to invest in a fund or selection of shares selected along a theme and looked after by an investment manager. Funds can be geographical (Asia, Japan), focused on performance (high dividend yields or growth) or the size or type of business (small companies or pharmaceuticals, for example). They all have a particular niche and each fund manager believes their selection is the best. As you can guess, they can’t all be right and there’s no such thing as the perfect fund, leading to a very wide range to choose from. There are some well-known fund managers such as Warren Buffett (Berkshire Hathaway) and Terry Smith (Fundsmith Equity) but success is never guaranteed, as proven by Neil Woodford’s fund collapsing in 2019. Buffett and Smith follow a similar mantra of buying shares in good quality companies at a fair price and then keeping them over an extended period of time. The intricacies of what constitutes a good quality company are detailed and subjective but include how resilient it has been over time, barriers to competition and consistent growth or dividends. Warren Buffett is also known as the ‘Sage of Omaha’ and is often quoted for his insight into how he has successfully invested over the years. You’ll find several of them, or versions of them, throughout this book, such as ‘Never invest in a company you don’t understand’ and ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.
Like shares, funds pay a dividend, which behave like individual share dividends. But unlike shares (where you pay a fee for buying and then selling), with a fund you pay a percentage management charge. This covers the cost of the management team who are looking after the investment decisions. Over my investing history, I’ve moved away from managed funds in favour of trackers but where I do have some, I still look at the fees in relation to their long-term performance and don’t think anything over 1% is good value (as an example, I hold some in Fundsmith Equity, which I mentioned earlier). Alongside fees and yield, there’s the physical growth of the fund, which again varies. Looking at Figure 7, you can see two funds with yields of around 6%, with 1% variance in fees. But their overall performance has differed: the table shows annual performance (fund growth) over the past five years (noting nearly all funds were impacted by Covid-19), with the final column showing the cumulative five-year growth. The third fund in this table has no yield quoted; it’s called an accumulation fund, where the dividend is reinvested (noting the higher cumulative growth). Funds where the dividend is paid out are called income funds. As you can see in Figure 7, performance is variable, making fund selection a challenge; popular platform Hargreaves Lansdown offers nearly 4,000 to choose from. Depending on their strategy, fund managers will buy and sell investments within their fund with the aim of improving their overall performance.
Fund
Yield
Fees
2018/19
2019/20
2020/21
2021/22
2022/23
5 Year
Jupiter Monthly Alternative Income
6.79%
1.70%
3.66%
-3.67%|
18.74%
-4.76%
-13.17%
-1.95%
Legal & General Strategic Bond Fund
6.10%
0.63%
5.21%
7.01%
9.67%
-9.77%
5.51%
17.47%
Barings Global Dividend
0.00%
0.86%
11.45%
3.97%
7.64%
