This is a guest article by Lars Kroijer.
From today you can invest up to £15,000 a year into your ISA. With rates on cash at historic lows, more and more people are looking to invest in the equity markets.
So is it time to find an expensive whiz kid fund manager who can turn your modest savings into millions?
Or maybe you’re the new Warren Buffett – should you get to work ferreting out some winning stock market investments?
Not so fast! (And I say that as a former hedge fund manager [1]
Getting to a great portfolio is quick and easy, but you need to make sure you’re going down the right road first.
I estimate it will take you another 300 seconds or so to read this article and discover how to create a portfolio that will deliver better returns than nearly all the expensive options out there.
Can you afford not to read on?
Don’t try to beat the market
Let’s start by accepting that you can’t outperform the financial markets. Don’t worry, virtually nobody can beat the market for long – very probably including those that sell you expensive financial products.
And you don’t need to beat the market anyway to get a perfectly good outcome from your investing.
So don’t buy any expensive funds!
Instead, I suggest you invest your ISA (aka NISA) into a simple portfolio that consists of just the following two investments, in proportions that suit your risk tolerance and stage of life [2].
#1: A cheap global equity tracker fund
If you are after high returns and can tolerate high risk, buy the broadest and cheapest equity index tracker you can.
You want an ETF or index fund that tracks the MSCI All Country World equity index, or something equally broad. Look at Vanguard, iShares, Fidelity, and State Street, or read previous Monevator articles for the very cheapest options [3].
A global tracker gives you maximum diversification at minimum price (perhaps 0.3% per year, pick the cheapest). It is probably the only equity exposure you will ever need to have, in your NISA or elsewhere.
Don’t buy funds that charge you more to actively pick a different set of stocks from the index.
They probably can’t do better than the index in the long run and the costs [4] will eat into your returns.
#2: UK government bonds
If you want minimum risk, buy UK government bonds [5] with a time to maturity that suits your time horizon. So if your horizon is 10 years, buy 10-year maturity government bonds, and so on.
If the bonds don’t match your time horizon, then you either end up trading shorter term bonds until your 10 years are up (which is an expensive headache), or you take unnecessary interest rate risk with longer term bonds.
UK government bonds are the highest credit quality security in the country, and this leg of your portfolio aims to give you security, not returns.
Again, you can get your bond exposure via an appropriate ETF – which saves you trading the bonds yourself. And again you should pay very little for it, perhaps 0.15% per year.
Look at the same cheap tracker providers for your bond fund as you did for your equity exposure. These companies are market leaders for a reason.
Blend your equity and bond exposure to suit
If like most people you want an exposure in between the two, mix the stock and bond ETFs accordingly.
- For a young person who can take a higher risk, perhaps a 75%/25% equity/bond split.
- For someone closer to retirement, perhaps a more conservative 25%/75% equity/bond split.
Whatever your exact split, this simple, low cost, two security mix portfolio will in my view provide you with a less complex and better risk/return profile than 95% of portfolios out there today.
Investing your ISA doesn’t have to be difficult or expensive to be effective.
Lars Kroijer’s Investing Demystified [6]
