Four ways to improve your returns in 2012
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Deputy Editor
Tim Bennett Jan 06, 2012
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Last year was a year to forget for most investors. Stockmarkets were battered by the European sovereign debt crisis, slowing growth in China and the other emerging economies, and by yet more attempts by central banks to prop up the global banking system. The FTSE 100 – which has been one of the better-performing markets – closed about 6% down on the year, and there’s little sign of the bad news flow easing up in 2012. But there are ways to ensure your portfolio is well prepared for whatever life throws at you – here are four strategies to bear in mind for the year.
Branch out beyond stocks
It’s tempting to stick to what you know. For many, that will mean stocks. There’s nothing wrong with that, up to a point – we’re very keen on income-generating, blue-chips stocks, and every portfolio should have some. But they aren’t the only source of income. The corporate bond market is becoming ever easier for retail investors to access, and 2012 looks like it could be a big year for this asset class: data from broker Evolution Securities suggest that issuance of these bonds will rise to £3bn this year, from £1bn in 2011.
What are they? Bonds are just IOUs issued by companies. The interest they pay can be fixed, or it can be variable (often linked to a measure such as the Retail Price Index inflation rate). Bonds still put your capital at risk (they are investments, not savings accounts), but bondholders come higher up the pecking order for repayment than shareholders if a firm goes bust. Like equities, bonds are traded in an open market at the London Stock Exchange. The key with retail bonds is that, unlike many corporate bond issues, they are easily bought by private investors, so you can buy individual company IOUs, rather than having to go through a fund. In the past we’ve tipped one of RBS’s inflation-linked bonds (GB00B4RM3T66) and a National Grid bond (XS0678522490) – both still look reasonable bets. But we’ll also be keeping an eye on the new issues promised in the year ahead.
Don’t overreact to bad news
In 2011, we saw revolt in the Middle East, disaster in Japan, near economic collapse in Europe, and upheaval in North Korea when the country’s dictator died. That’s enough to get any investor feeling punch drunk. But the fact is that markets tend to shrug off even seemingly catastrophic events. That’s because they are generally looking elsewhere. US employment data matter far more to the share price of most major blue chips than even a major earthquake, for example, provided the impact is isolated. So following disasters of all kinds, after an initial panicky slide, prices usually recover quickly.
Don’t feel obliged to rearrange your portfolio every time there’s bad news in the papers. Remember that every time you trade, it costs you money. So keep calm, and never be bounced into pressing ‘buy’ or ‘sell’ by a flashing headline.
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Keep some cash
With interest rates on bank accounts so low, it’s tempting to abandon cash altogether. But as Dylan Grice at Société Générale notes, “as an asset class, cash doesn’t get the attention it deserves”. There are three good reasons to hold it. First, it has zero valuation risk – in short, it doesn’t go ‘down as well as up’. At a time when other asset classes (such as commodities) come with huge price risk (or volatility), that’s not to be sniffed at. Second, cash proved a decent inflation hedge during the 1970s – or at least no worse than equities and bonds – and a decent deflation hedge in Japan from 1990 to 2011. In other words, it’s an asset for all seasons.
And it’s no good slavering over bargains as asset prices fall if you can’t take advantage. To do that you need some cash – its flexibility and price stability give it what Grice calls “dry powder value”.
Don’t pay for complexity
The financial industry is inventive. When it senses that you are jittery, it’ll come up with products that promise you a ‘no-lose’ deal. So they offer ‘structured products’, for example, which offer a fixed return if markets rise (so you’ll get ‘x%’ of the rise in the FTSE 100 over a certain number of years), plus some sort of money-back guarantee if markets fall. In theory they are perfect for the concerned investor. In reality, most are rip-offs. Charges tend to be high, the payouts subject to all sorts of caveats, and you often can’t back out early. Much of the time you won’t get paid dividends (a vital part of long-term returns), and, should the scheme’s guarantor go bust, you could be seriously out of pocket. They are complex and expensive, and we’d avoid most of them.
It’s a similar story with complex exchange-traded funds (ETFs). For us, the point of an ETF is that it tracks an index simply, cheaply and accurately. So avoid the ones that do not; anything with ‘leveraged’ or ‘inverse’ or ‘leveraged inverse’ in the title, for example, are best left to traders – they are only really suitable for short-term bets.
In a nutshell, investing is best kept simple. So if you don’t understand it, don’t buy it.
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