Whilst some investors select specific stocks, most investors use collective investment schemes. This makes a lot of sense as it reduces risk for the investor.
Collective investments are funds where the monies of a large number of investors are pooled together under professional investment management. The investment manager then acts collectively on their behalf.
The most popular collectives are unit trusts, investment trusts and Open Ended Investment Companies (OEICs). Then there are offshore funds, with-profit funds, commercial property funds, corporate bond funds, exchange traded funds (ETF’s) et alia.
Of course, some people prefer to invest direct. This obviously takes a lot more time for them to do all the research – ideally beyond just reading the financial press. The problem is that, as several independent research studies show, people who invest direct tend to do worse than institutional investors for various reasons, mostly due to their own actions. These include lack of diversification, compulsive trading, buying high, selling low, going by hunches and simply by responding to media and market noise.
The latter often means that such investors end up investing on the basis of past performance. They read about good past performance for a 12 month period and then invest, when there is no certainty that this will lead to better returns the following year.
Financial markets are often cyclical and the key to successful investment (as opposed to day trading) is not timing but patience. A buy and hold strategy may not be as sexy and exciting but it seems to work most of the time. On the other hand, becoming addicted to trading does not help in most cases.
A lot of the above behavioural traits that end up causing investor problems stem from over-confidence. In reality, what is required for most individual investors is to get their egos and emotions out of the investment process. One answer is to distance themselves from the daily noise by talking to an independent financial adviser (IFA), such as Kellands, to help stop them doing things against their own long-term interests. It is quite likely that the financial adviser will recommend collective investments.
The major benefit of collective investments is that they can reduce the risk of investing by spreading the risk of your investments. The fund manager is able to purchase a far greater number of investments than the individual investor possibly could. Because of this, the possible impact on the collective investment fund caused by one particular investment performing badly is low, as it forms only one small part of a much larger investment portfolio.
Collective funds also provide a higher degree of diversification. For example, if you were looking to invest in UK smaller companies, it would be impractical (in terms of costs and research time) to invest in more than a couple of companies. A fund manager, however, can buy shares in many companies and spread the investment further.
Collective funds can also be used to gain specific exposure to a specialised market where direct investment would be too risky or expensive. A UK investor would find it both easier and safer to buy a collective investment in Far East markets for example, than to try and buy shares in individual companies listed on any of the stock exchanges of the Far East. Holding investments in more than one geographical region can also form part of a diversification strategy.
Another benefit is the extensive level of research available to fund managers. As well as their own in-depth knowledge, fund managers have the support of a team of researchers and analysts behind them to monitor markets for new opportunities as well as potential problems. It would be impossible for a private investor to conduct a similar level of research into as many companies as a professional fund management group.
Fund managers also have access to markets and instruments where individual investors don’t have the knowledge, capital or perhaps even the legal right to invest. This includes hedge funds, emerging markets, private equity situations and complex derivatives.
With thousands of collective funds to choose from, the question is how to pick the best funds for you? It is not an easy process, even for professionals. But getting quality financial advice from an independent financial adviser should certainly help you with your overall investment planning.
Contact Kellands now to find out more.