INVESTING AND TRADING The value of advice when trading shares Shaun van den Berg Head of Client Education PSG Wealth
A solid investment foundation is crucial to achieving long-term success. In the words of author Stephen R. Covey: ‘If the ladder is not leaning against the right wall, every step we take just gets us to the wrong place faster’. We apply a number of timeless investment principles to ensure that we are helping you to grow your clients’ wealth. These aren’t new to you, but we hope that this handy reminder will be useful to share with your clients, especially if they display an interest in trading shares or other instruments.
Diversification reduces risk When it comes to risk, Warren Buffet is famous for saying, ‘Rule number one: never lose money. Rule number two: never forget rule number one’. When it comes to helping clients build a share portfolio and managing the risk of loss, diversification is important. Investing in at least eight to twelve shares across three to five different sectors can help reduce risk. Correlation is important as well. If you choose to spread an investment, it pays to spread this across various sectors with low correlation to each other.
A diversified portfolio is still subject to market risk While minimising risk is important, anyone who is investing in shares should want to achieve better investment returns than the market average. No matter how diversified a share portfolio is, you can never eliminate risk completely. You may avoid the risks associated with individual shares (‘unsystematic risk’) by diversifying a portfolio, but there is still a risk of an overall market correction (‘systematic risk’) that can affect most shares.
A diversified portfolio may dilute investment returns If you are invested across five sectors, and one performs exceptionally well, your gains will be diluted compared to if you were invested in that one sector alone. The more extensively diversified a share portfolio, the greater the likelihood that its performance will therefore, at best, reflect the performance of the overall market. It is a continuous process to manage the balance between concentration in certain shares and sectors, and the diversification of your portfolio.
Decide on an appropriate investment strategy An investment strategy can provide a way to select shares to include in a portfolio. Below is a summary of common investment strategies, which can be used individually, or in combination with one another. • Income investing aims to generate income by investing in shares that pay relatively high and regular dividends. • Value investing involves looking for shares that are undervalued, and buying them for less than what they are worth. • Growth investing focuses mainly on companies that show signs of above-average growth. • GARP (growth at a reasonable price) investing is a sound strategy due to it combining both the value and growth strategies, offering the best of both worlds. It involves investing in companies that are somewhat undervalued but still have solid sustainable growth potential.
Professional advice can minimise costly mistakes Irrespective of whether you manage a share portfolio for certain clients on a discretionary or non-discretionary basis, it pays to help clients become more informed about investment basics. These basics can help them avoid making costly mistakes. We hope that this summary provides you with a useful tool to use in your discussions with clients. It may act as a catalyst to help them understand the complexities inherent in trading shares; and warn them about the dangers of going it alone when it comes to trading the range of other complex instruments available through our platform.
Guard against over-diversification One of the advantages of a more concentrated share portfolio is that while it does increase risk, it also increases potential reward. Share portfolios that deliver the highest returns are typically not widely diversified, but rather have investments concentrated in a few carefully selected industries or market sectors that outperform the overall market substantially. A more concentrated portfolio also enables investors to focus on a manageable number of quality shares.
THIRD QUARTER 2016