Vanguard Asset Management has come up with four tried and trusted principles to help investors choose the right strategies for their stocks and shares ISAs, and to manage their portfolios on an ongoing basis.
James Norton, head of financial planners at Vanguard in the UK and Europe, said the four steps are goals, balance, cost and discipline.
The starting point is to understand why you are investing and what the money is for. Is it for a deposit on a property in five years or are you saving towards your retirement in 30 years’ time?
Those goals will determine the next point, balance, which is synonymous with diversification and asset allocation. Norton thinks investors should begin with global equities and global bonds, although the allocations to each will depend on an investor’s time horizon and risk appetite.
“A really great starting point for all investors is a low-cost, globally diversified equity index fund and for some people that is all they need,” he said.
Investors might choose an exchange-traded fund (ETF), which can be bought and sold during the London Stock Exchange’s opening hours, just like shares, or a passive fund with daily liquidity.
Some investors add actively-managed equity funds, but Norton thinks that involves greater risk. “The fact of the matter is that some managers have outperformed but the majority haven’t and you risk that underperformance in the potential of making higher gains,” he said.
Investors can still express a view through their choice of passive vehicle. For instance, the Vanguard ESG Global All Cap ETF excludes ‘sin stocks’ such as alcohol and tobacco, while the Vanguard LifeStrategy 100% Equity fund has a home bias, with 25% in UK equities. The fees are 0.24% and 0.22% per annum, respectively.
Unless investors have a very long time horizon and/or a considerable predilection for risk, Norton recommends adding fixed income. “Equities are volatile. They’re the engine for growth but portfolio volatility can be mitigated by holding some fixed income.”
After a couple of difficult years for bonds and an aggressive rate hiking cycle, yields are now relatively high. “We think the outlook for fixed income is much, much better than it has been for many years,” he said.
Bonds issued by governments, supranational organisations and corporations with a good credit rating will provide better diversification against equities than high-yield bonds which have equity-like returns, Norton explained.
“The quality of fixed income is important because fixed income is there to act as the buffer, the safety value if equities perform less well. And what you tend to find is that if equities sell off, then low-quality fixed income can perform badly as well.”
As with equities, Norton believes fixed income exposure should be low cost and globally diversified.
Cash is crucial, too. Before they start investing, people need to have sufficient savings for emergencies, he noted.
The third step in the four-point plan is cost, including fund fees and platform fees, so investors should shop around. The inverse relationship between costs and performance is counterintuitive because “in most areas of life, the more you pay, the more you get”, Norton added.
Discipline is the fourth and final step. “This is the hard bit because this is about behaviour,” Norton said.
“So you’ve thought about your goals, you’ve created the portfolio, you’ve implemented it at low cost. But then you need to have the courage of your convictions and stay the course. Don’t get distracted by the noise.
“There are so many professional pundits who have strong views and convictions on what sector is going to perform better, whether you should sell the US and buy emerging markets or go short on this and long on that. And actually, if you’ve done the first three steps and you consciously do nothing or occasionally rebalance the portfolio, you’ll be better off than most investors.”
This is because long-term strategic multi-asset funds tend to outperform short-term tactical asset allocation, Norton said, and market timing is notoriously difficult. “We firmly believe at Vanguard that investors should concentrate on what they can control.”