How to build a low-cost amazing stock portfolio in 8 steps
This blog shares information on investing and saving but does not provide personal advice. Please seek professional advice from a financial advisor if you are unsure which investments are right for you. Investments can go up as well as down in value, and you may lose your money.
I started investing in oil via spread betting, and in the space of 3 months, when the oil price jumped from $30 a barrel to $65 a barrel, I still managed to lose £3k even though I “knew” the oil price would go up. I learnt my lesson the hard way!
One evening, I stumbled across the Warren Buffet documentary and through that, I read Benjamin Graham’s Intelligent Investor and Security Analysis. In particular, Intelligent Investor changed my life, and by applying the ‘value investing’ lessons in that book, I manage a modest portfolio in stocks (mainly low-cost index funds).
I wanted to share the steps on how to start investing and come with a reasonable portfolio in this blog post!
This is not meant to be a ‘get rich quick scheme’. If that is what you are after, this is the wrong place for you to be. For the most part, investing is very BORING, DULL and offers little excitement. Investing relies on you for the vast majority of the time to pay little attention to what the market is doing and DO NOTHING.
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Step #1: Before committing any money, you need to figure out if investing in the stock market is really for you.
DO NOT GO INTO THE STOCK MARKET IF YOU ARE NOT WILLING TO KEEP THE MONEY INVESTED FOR THE NEXT 20 YEARS (AT LEAST).
A lot of your success/ or failure will rely on you being rational and not making an investment decision based on emotion. One of my favourite quotes from Intelligent Investor is that the markets are completely irrational and, for most of the time, spouting complete garbage. You want to profit from this stupidy not participate in the stupidity.
The greatest gift that the stock market provides is compound interest. Steady investing over a long period of time with profits reinvested means that the result can be spectacular.
As an example, if £100 was invested every month for 25 years, compounding at 10% per year would give over £130k vs a deposit of around £30k!
The only consistent method for successful results in the stock market is from people being able to put money away for long periods of time – 25 years plus and reinvesting their profits.
Investing is not for everybody. INVESTING INTO THE STOCK MARKET ON A SHORT TERM BASIS WILL MOST LIKELY LEAD TO POOR RESULTS AND THERE IS A GOOD CHANCE YOU WILL LOSE YOUR MONEY
Step 2: Assuming you are ready to plunge into the markets, you need to decide what to invest in.
Stocks, Bonds, EFT, Funds, what do I go for?
Should I Buy and sell individual company stocks?
For 99% of the population, I would advise against buying and selling individual company stocks.
I used to buy and sell my own stocks. (and did OK – BUT)
- Buying and selling your stocks takes a HUGE amount of research and reading to decide if investing in a given company makes sense.
- With us not being interested in ’emotional gambling’ on the stock market, when determining when to buy or sell a stock, you need to first of all figure out how much a company is ‘worth.’
- The only way to reach a sensible conclusion is by balance sheet analysis, reviewing the financial reports. Security Analysis is a fantastic book to understand balance sheet analysis and the margin of safety principle.
- From your balance sheet analysis and reviewing quarterly and annual reports going back many years, you can then come to a conservative value of what you think the company is worth
- If the company is selling at a significant discount to your ‘valuation’ then you would consider buying the stock. Once the price recovers, to a point that is selling what you consider a fair price or higher, you sell.
- The difficulty of buying and selling individual stocks and going through methodically is the amount of time it takes. Warren Buffet reads for 7 hours a day every day! If you are not prepared to do this amount of research (most of which will bring you to the conclusion not to buy, you are wasting your time).
- Even if you have the time available, most DIY investors with modest portfolios (less than £500k) will find the brokerage fees and other associated costs e.g. Stockopedia stock screen, will make running the portfolio prohibitively expensive.
- For example, if you have a monthly cost of £50 in fees on a £20k portfolio, that would cost you annually 3% before you have even gotten out of the blocks.
- The best professional investors in the world have growth of around 15% a year give or take. Assuming, you as a DIY investor have amazing abilities and can match this performance (unlikely), the best result you could possibly ever hope for is a return of 12%.
The truth is most professional fund managers in a given year will lose money. So as a DIY investor, trying to build a portfolio around a full-time job, it becomes easy to see why the majority of DIY investors lose money when buying individual company stocks.
Step 3: Invest in low-cost index funds over a long period of time and forget about it!
I absolutely love low-cost index funds for several reasons. DIY investors can purchase low-cost index funds typically at a cost of less than 0.2-0.5% per year.
Index funds deal with the problem of diversification very well. Taking a FSTE 100 index fund tracker as an example (I used the iShares FTSE 100 EFT) and the ongoing charge for that a year is 0.07%! The great thing about the FTSE 100 is that over the last 30 years, it as grown by an average of around 10% per year.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE PERFORMANCE
For the DIY investor like myself – this is good enough for the risk vs reward. The best investors in the world are growing at 15% a year. I could never hope to reach that level of performance. For relatively little fuss and difficulty, by investing in an index fund I get myself 10% a year (average of the last 30 years).
Index funds means I don’t have to bother reading annual reports, being on investor calls, worrying, when to buy and sell etc!
Step 4: Set up a system to stop yourself from becoming an ’emotional investor’ and getting influenced by the ‘herd’.
The vast majority of so-called investors will pour money into an investment with little diversification because someone ‘said’ stock x,y,z was an excellent buy. Or they purchase because they think stock x y z will go up.
The markets go up, they get euphoric with the gains they have made and decide to buy some more at ever-higher prices. Suddenly, there is a price correction and the stock starts to fall. The investor is now in a loss-making position.
As the stock starts to fall further, the investor then panics about losing their money and sells at a loss. Because everyone else is selling at the same time, prices fall further as there are not enough buyers to meet all the sell demand.
This is what is called herding. What the investor in this case has done is to buy high and then sell low. The investor then decides the stock market is risky and moves on to other things!
Although this post is not concerned with investing in individual stocks, (low-cost index funds is my prefered option), it is important to have a system to manage our emotions and ignore all the rubbish we are fed on the news, from our friends giving tips etc.
Step 6: Golden rule- always keep 25% in ‘Cash’ via inflation-linked government bonds.
Keeping 25% in inflation-linked government bonds acts as a natural buffer in forcing you to sell as prices rise and buy when prices are low (i.e. when everyone else is selling).
Let me illustrate.
The start
Portfolio of £1,000: £250 (25%) in inflation-linked government bonds and £750 (75%) in low cost index funds.
Markets rise by a whopping 50% (just for illustration!)
The portfolio is now worth £1,375: £250 (~18%) in inflation-linked government bonds and £1,125 (~81%) in low-cost index funds.
To observe the 25% cash via inflation-linked bonds rule at all times, it would be necessary to sell some of the stock to rebalance the portfolio.
Rebalance:
Portfolio is now worth £1,375: ~£344 (25%) in inflation-linked government bonds and ~£1,031 (75%) in low cost index funds.
The 25% in cash via inflation-linked government bonds means that you are naturally selling high as the markets are rising. Conversely, if the markets decline heavily (as they did during COVID 19), your available cash proportion will increase comparatively.
This would then force you to BUY when everyone else is selling and the prices are low. One of the best periods I had with my portfolio was making significant purchases in early April 2020, when the stock markets globally had plunged by as much as 50%.
What I loved about intelligent investor was the advice to treat stock market declines as a ‘sale’ or a discount opportunity. The majority sell as markets decline because of emotional fear and excessive pessimism.
Having 25% in cash means you do not have to make these emotional decisions and follow what everyone else is doing and panicking. Instead, you can sleep easy at night, knowing that you do not have to predict what the market is doing.
You simply wait until the market presents you with a low price to buy (because you have the cash). And equally, as prices are increasing, you wait for the market to give you a high price and sell on the way up.
The reason why investing is difficult is that most people do not have the temperament and the discipline to sit through at 40% or 50% market decline and then go and buy when everyone else is on the way out.
I have found the 25% rule gives an almost mechanical way of decision making that detaches you from making emotional decisions. I strongly believe the biggest obstacle to successful investing is yourself, so having a framework to work within will avoid you falling into the market’s many emotional traps.
Step 7: Choosing a stockbroker
In order to buy index-linked bonds or low-cost index funds, you need to find a broker. I use Hargreaves Lansdown for my Self Invested Pension Plan and FreeTrade. There is no perfect stockbroker as who you choose will depend on the amounts you have to invest and the fees they charge.
For those with relatively modest amounts, you may prefer to go with a provider that charges a percentage of the amount invested rather than a fixed monthly amount.
For those with larger amounts, it may make more sense to go with a broker that charges a fixed monthly amount, e.g. £9.99 per month, because you have a much larger amount, so the broker fees would have a much smaller impact on the portfolio.
The goal at all times is to keep the costs as low as possible!
You also need to consider what the charges are to buy and sell with each broker. With HL, for example, buying and selling funds is free. With FreeTrade, buying and selling shares are free but they do not allow holding of funds. Figure out what works best for you and get professional advice.
You can buy low-cost index trackers either as an ETF (exchange-traded fund). EFTs are treaded like a stock when it comes to how you buy and sell them. You can also buy low-cost index funds as an actual fund.
The key at all times is to minimise your broker fees. The lower you can keep you broker fees, the better your portfolio performance will be.
Step 8: balancing a portfolio
Periodically, it is essential to rebalance a portfolio to make sure it does not get out of shape. If prices have risen, you sell enough to bring the various positions you have back to where they should be (25% in cash/ inflation-linked bonds).
Equally, if you find prices have had a steep decline, then that provides an excellent opportunity to use some of your cash/ inflation-linked bonds to but more equities. If prices fall further, then that again provides another buying opportunity. The key is to maintain your 25% cash/ inflation-linked bonds.
The 25% is what I have used as a guide. Still, if you feel that for whatever reason, stock equities valuations are excessively higher than is warranted, then there is nothing preventing you from holding more than 25% or maybe even increasing it to 40% – 50%.
In terms of how often to balance a portfolio, I rebalance every 6 months. This is a personal preference, so figure out what would work best for you. You do not want to balance too often, i.e. every day, as potentially you may end up spending huge amounts on stockbroker transaction frees.
Minimising the amount of buy/ sell actions on your account in most cases will reduce the overall cost of the portfolio in terms of broker fees.
The key to successful investing is really long term exposure to a diversified range of stocks and reinvesting your profits. Good luck!
If interested these are the low cost index funds I hold with Hargreaves Lansdown:
| HSBC European Index Class C – Accumulation (GBP) |
| HSBC FTSE 250 Index Class S – Accumulation (GBP) |
| iShares Emerging Markets Equity Index Class H – Accumulation (GBP) |
| iShares III plc S&P SmallCap 600 (GBP) |
| iShares Japan Equity Index Class H – Accumulation (GBP) |
| iShares Pacific ex Japan Equity Index Class H – Accumulation (GBP) |
| Legal & General UK 100 Index Trust Class C – Accumulation (GBP) |
| Legal & General US Index Class C – Accumulation (GBP) |
| Legal & General Global Inflation Lnk Bond Indx Class C – Accumulation (GBP) |
I use the Legal & General Global Inflation Lnk Bond Indx Class C – Accumulation (GBP) for my 25% cash/ inflation-linked bonds requirement. Since I started investing through low-cost index funds 4 years ago, my average annual compound growth rate is 9.7% growth each year.
I AM NOT A FINANCIAL ADVISOR. This blog shares information on investing and saving but does not provide personal advice. Please seek professional advice from a financial advisor if you are unsure which investments are right for you. Investments can go up as well as down in value, and you may lose your money.
