Simple Pound

Okay, you can breathe again. I haven’t actually lost money, but simply reduced the value of my model (!) portfolio by 1.5% yesterday. At work, my team decided it would be fun to see who could make the most money out of £1,000,000 and hence we all started our own little fake portfolios.

Yesterday was the first day that my portfolio, which I had set up over the weekend, was actually subjected to the market and, well I have lost a staggering total of £16,875.24. Of course, I forgot absolutely everything about thorough company research, diversification and asset allocation and simply bought what I thought would make the most money in the fastest possible way (guess that didn’t work, huh?). In my defense, this trial has more to do with competitive speculation than actual investment and hence the it becomes much more of a gamble than stock market investing should be (at least if you eventually want to live of your return!).

I thought you might be interested to see what “horses I bet on” and whether I had an ever so vague reason for doing so (follow link!):

• 3i Group (III): Venture capital firm that favours tech start-ups; + 1.98%
• Anntaylor Stores (ANN): Women’s clothing retailer in US - reason? I contributed to way too much to their profits and now I want something back! +3.24%
• Apple Inc (AAPL): manufacturer of personal computers and related software - some people seem to want to spend a lot of money on the iPhone (why?); -7.02%
• Archer Daniels Midland (ADM): agricultural processing company; -2.22%
• Atlantia (ATL): Italy’s largest operator of motorways; +1.57%
• Banco Santander (SAN): Spain’s largest bank; +0.20%
• Bateman Litwin (BNLN): oil equipment services and distribution sector; +4.44%
• BG Group (BG): Gas and oil exploration arm of old British Gas and major player in global energy market; -2.74%
• BTG (BGC): pharmaceuticals & biotechnical sector; -3.20%
• Carphone Warehouse Group (CPW): Europe’s largest independent retailer of mobile communications; -0.84%
• Clean Harbors Inc (CLHB): I don’t even know what they are/do… was recommended to me (ah well); +0.70%
• Exxon Mobil (XOM): used to be world’s largest publicly traded energy company; -2.73%
• First Group (FGP): one of Britain’s largest transport companies; 0.48%
• Google Inc (GOOG): search engine and do-gooder (*lol*); -4.80%
• L’Oreal (OR): cosmetics group - I love Lancome products and yes I am aware that this is a very girly reason for investing in a company; -1.15%
• PetroChina (PTR): Chinese energy company with market cap of $1,000bn - new world’s largest energy corporation; -5.39%
• Petroleo Brasileiro (PBR): also “PetroBras” - Brazilian oil company announced discovery of new oil field; -11.77% (do you get that??)
• Premier Foods (PFD): food manufacturer; +3.45%
• QXL Ricardo (QXL): online auctioneer; +3.87%
• Rio Tinto (RIO): Mining company for aluminium, copper, gold, diamond, iron and lead; +0.60%
• Rheinmetall AG (RHM): German defence company; +0.45%
• Ryanair Holdings (RYA): no-frills airline operator; -0.20%
• Siemens (SIE): German engineering and mobile phone company; -1.13%
• Telefonica (TEF): communications company who owns O2; +0.89%
• Tiffany and Co (TIF): internationally renowned retailer, designer, manufacturer and distributor of fine jewellery - again active profit contribution on my part; +3.28%
• Vallourec (VK): French steel tube-maker subject to take-over rumours; +2.14%

Let’s see how today’s market will be treating my portfolio…

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I don’t know about you but I’m starting to feel a little dizzy with all these investment options available. Until I’ve properly tackled all the options I’ve covered so far, I decided to not add any more to the (already) extensive list.

Of course I could go on talking about options, futures, exotic derivatives, commodities, currencies, real estate… but since I don’t see myself investing in any of those very soon, I won’t bother researching any details on them - yet.

In case you’ve missed a post of the “Investment Choices” series, here a brief overview:

• Shares: a very gentle introduction to what shares/stocks are
• ETFs: a first dive into the world of funds with exchange traded funds
• Index funds: passively-manged funds that aim to track the performance of a stock index. Commonly called “tracker funds” in the UK.
• Mutual funds: actively-managed funds where the fund manager picks shares in order to beat the stock market or achieve a certain objective. In the UK referred to as “investment trusts”.
• Bonds - part 1 and part 2: an excursion into debt securities with a gentle reminder that - assuming you’re young - this investment should by no means dominate your portfolio since the associated low risk won’t earn you decent (enough) returns.
• Bond funds: through the advantages of debt securities joined with the advantages of funds, bond funds are a good way of generating passive income.
• Unit trusts: UK investment jargon explained - part 1
• Investment trusts: UK investment jargon explained - part 2
• OEICs: UK investment jargon explained - part 3

Reading through the above list I feel re-confirmed that there are plenty of options to choose from when building a first portfolio. Let me know if you disagree or want to know more about anything else I haven’t covered so far!

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There are tons of possibilities out there to invest and hopefully grow your money and the current obsession with derivatives certainly doesn’t limit that choice. Personally, I will stay away from derivatives until I can be sure that I understand what’s going on.

But let’s start with the basics and give you an overview of the most common investment choices. There’s on simple rule that applies to all of them: More risk, higher return. Whether you decide to keep your money under your mattress (and thus effectively lose money due to inflation) or invest it in a small start-up company depends entirely on you and your risk attitude.

A rule of thumb that is commonly used to determine the ratio of bonds and stocks in your portfolio is 120 - age. This is the proportion you should invest in equity (i.e. shares, equity-based funds, index funds etc.) and reflects the time you have left until you retire (if you are retiring in 5 years you will mind if your portfolio drops by 20% whereas if you have 40 years left you know you have plenty of time to make up for it). In my case this would be 120 - 20 = 100% in stocks, which is what I intend to do - after I’ve got some money sitting in a savings account with a sign round its neck saying “emergency fund”. At which point I can probably already invest 1% in debt-based securities (bonds…)

I intend to break up this post into smaller chunks which should hopefully assure that (a) you don’t fall asleep, (b) you can look up the things you don’t know and (c) I don’t have too many good reasons to procrastinate from doing my revision.

So here we go with probably the most obvious choice: Shares.

Buying shares in a company effectively means you’re buying a tiny part of that company and thus have a right to have your share of their profits. Now with hundreds of thousands (or even millions, depending on the size of the company) of shares in issue this mostly boils down to a few pence per share. The profit is distributed to the shareholders (that is you) through dividend payments. Having said that, there are some companies who are not making any dividend payments but instead are using the profits to re-invest and grow the company. Depending on whether you want a solid income stream or growth from a share, you will have to make your choice.

The former group of shares is often classified as income shares, because they provide guaranteed income on a (semi-)annual basis. These companies are usually large firms whose demand doesn’t depend on economic conditions (utilities or pharmaceuticals come to mind) and you thus distribute their cash reserves to the shareholders. Likewise, these companies usually have a phenomenal market capitalisation (= share price x number of shares), which means that buy and sell transaction don’t affect the share price as much (Microsoft currently has a market cap of $280 billion). This however also implies that the share won’t grow as fast as a smaller share could. In short: the dividend payments are intended to make up for the lack of growth that can be expected.

Therefore, many of the companies classified as growth shares won’t belong to the category of dividend-paying companies (as with everything this is not a black-and-white decision - dividend policies can change and growth shares can also pay the odd dividend, but I’m talking stereotypes here…). These companies usually belong to more volatile market sectors (media, technology) and use all profits that are left over (after interest payments and tax) to fund further investments and thus grow the company. This will (hopefully) be reflected in future income statements (i.e. future profits) which in turn will help convince further investors to join the group of shareholders. Because these companies are usually smaller than income companies they are subject to greater share price movements - and as long as those are in the “right” direction, investors will make money through the increase in value of their shares.

Both income and growth shares belong to the category of common stock, which means that you invest in the ownership (equity) of a company and are allowed to vote for the board of directors every year - who are supposed to represent and act in the shareholders’ best interests. This, however, also means that in case of bankruptcy your claims towards the liquidated assets of the company are subordinated to preferred stockholders.

Owners of preferred stock are owning a part of the company in the same way that owners of common stock do, but with the major difference that dividends paid to preferred stockholders are usually fixed and paid out before the dividends to common stockholders whose dividends are variable (if paid at all). While this promises greater security, the old trade-off kicks in that determines “where there’s lower risk there must be lower return”: preferred stockholders don’t benefit from any growth in profits in much the same way as they don’t lose when profits plummet (as long as the company remains profitable - if it doesn’t, dividends are usually accumulated over time and paid as soon as profits allow).

This was surely a fairly lengthy introduction to the concepts, but I hope it was nevertheless helpful. If you want to read even more about shares and share categories now, I recommend you start here and here.

Read part 2 of “Investment Choices” on exchange traded funds >>

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