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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After I diverged a little bit from my original investigation into investment choices, let’s return and have a closer look at mutual funds this time.

I have already discussed index (tracker) funds in great detail, and while mutual funds and index funds do share some features, in most ways they differ significantly. You’ll hopefully soon see why.

Just as index funds, a mutual fund is essentially a collection of shares bought and administered by a fund manager. Mutual funds can be either bought with the fund company directly or through a normal broker and thus simply like you would buy any other share. While the shares of exchange traded funds (ETFs) are priced throughout the day (which is why they are often compared to ordinary shares) and can thus vary in value throughout the day, mutual funds are only priced once - at the end of the market day.

So why invest in mutual funds? The answer is simply - and you probably would have guessed - diversification. If many people invest in the same fund, large sums of money are made available to spread the investment over a variety of sectors, shares, countries and markets - something you clearly couldn’t achieve on your own, at least not if you don’t belong to Britain’s richest 5. Moreover, mutual funds are actively managed (remember that index funds where what is called “passively managed”), which means that some people devote their entire careers to picking stocks for you. That means they spent their entire days researching companies to find the next winner, the one company that is going to outperform the market in the long run (if it exists).

The advantage that should come with a dedicated fund manager is generally a better performance than e.g. an index like the FTSE 100. Since these people should be able to eliminate the companies whose shares are going to go down, right? Well… sort of. But even those fund managers are human after all, so in the end they are probably bound to make a mistake at some point. The truth is, that only about 15% of available mutual funds outperform the market in the long run. Therefore you will need to do your homework for funds just as you would for company shares.

The downside of actively managed investments is that you will need to pay the person who is doing all the work for you - after all, they want to pay off their mortgage too. This implies that the expense ratio of mutual funds will generally be higher than that for index (tracker) funds, and commonly accompanied by advertising expenses and a high turnover through a more frequent buying and selling of shares than mirroring an index would require. Since every buy- or sell-transaction incurs additional costs the most amazing gains could be eaten away by these additional expenses - a fairly good reason to do your homework properly.

Read part 5 of “Investment Choices” on bonds >>

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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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Warren Buffett is possibly one of the most successful investors - ever, and with a personal net worth of roughly 30 billion dollars he is certainly among the world’s richest.

While one would expect complex technical analysis dominating his mind from the moment he wakes up in the morning, his investment philosophy boils down to something rather simple:

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” (source)

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I have never written a blog before. In fact, I was always fairly unreliable at keeping journals, but this time I have a purpose… I am going to graduate in less than 3 months time and will be earning my first salary. And I think this is a pretty good reason for starting to think about money. There are many, many things I want in life - including material things that come at a cost. And don’t misunderstand me, I love luxury - I love fast cars, good restaurants, quality clothes and cosmetics. But I think it should be possible to afford all these with a little bit of planning and without going into debt.I’ve be using this blog for two purposes: Firstly, I want to keep track of what I’m learning and reading about elsewhere and bundle all this (for me) useful information in one place. And secondly, I want this blog to be my source of motivation where I can keep track of my (financial) goals and encourage myself not to indulge in impulse spending.

So what are my goals?

• Pay back (some of) the money my parents lent me to finance my studies - unfortunately that also includes paying a rather large outstanding invoice for repairs on my mother’s car.
• Fully fund my cash ISA for the tax year 2007/08 - the interest earned on that money is tax free and I don’t want waive free money (especially not when it comes from the government…). I intend to use this money only for long-term purposes. That ultimately includes retirement, but since I’m only 20 years old there will be a few other major expenses (property etc.) beforehand that I plan to cover as effortlessly as possible.
• Accumulate an emergency fund of 3 months worth of expenses - as I am about to move to London, I don’t have much of an idea what amount of money I will need to put aside, but I will find out.
• Build up a diversified portfolio of investment funds - at first, these will largely be index funds but I shall also look into mutual funds to aim for a little more aggressive growth. Following the saying “don’t lay all your eggs in one basket” I will try to diversify the portfolio not only by taking into account the funds’ objectives but also their location - starting off in the UK, I plan to diverge into European, American and international funds, maybe even test out emerging markets.
• Gain experience with individual shares and other alternative investment possibilities - here I will start off with growth shares, on which I have just recently read a fantastic book called “The Zulu Principle” by Jim Slater. Even though it is more than 10 years old by now, I found it very enlightening and helpful - how helpful it will prove in practice shall be seen.

These goals are loosely ordered by both importance and amount of money involved. I will not jeopardise any money on the stock market until I have put enough aside to deal with potential losses. Once I start actively pursuing these goals I plan to put up a graph to track my progress - just like the guys at We’re in Debt did. I hope this will help remind me that I don’t really need that extra pair of shoes until I’ve secured all free money from the government…

And now I really need to go and do some more revision…

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