DIY Investor Diary: how I invest to preserve wealth

In our new DIY Investor Diary series, we speak to interactive investor customers to find out how they invest in funds and investment trusts, what their goals and objectives are, current issues and concerns regarding their portfolio, and what they’ve learned along the way. The premise is to try and provide inspiration to other investors, and we would love to hear from more people who would like to be involved. We do not require those featured to be named. If you are interested, please email our collectives editor directly at: kyle.caldwell@ii.co.uk

One of the golden rules of investing is to spread risk far and wide by having a diversified portfolio. This is achieved through mixing a range of stock market investments with other investment types, primarily bonds and commercial property.

The theory is that different types of investments are unlikely to all outperform or underperform at the same time, which therefore reduces the volatility of your overall portfolio. Due to the fact that investments perform differently relative to each other every year; a mixed investment approach gives a portfolio ample opportunity to grow, while at the same time guarding against serious short-term losses.

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The second DIY investor in our new series is not only diversified by asset class, but has also spread risk by owning a mix of active and passive strategies.

The DIY investor, who is a 63-year-old male and retired a couple of years ago, is not currently drawing on his investments, but has put a plan in place to do so in the coming years.

He has both an ISA and a SIPP, but will be looking to cash in income returns or sell fund units out of the ISA first due to the fact that pensions are not subject to inheritance tax.

Given that the ISA will be utilised first, our investor has structured this tax wrapper to be less risky than the SIPP. It has greater exposure to income-producing assets. Overall, it contains 17 holdings, with 13 active funds. His holdings include Fundsmith Equity, Personal Assets (LSE:PNL), Capital Gearing (LSE:CGT) and TR Property (LSE:TRY).

The SIPP contains 15 holdings, of which 10 are a diverse spread of passively managed index funds, including L&G International Index, Vanguard LifeStrategy 80% Equity, and Vanguard Global Small-Cap Index, while Scottish Mortgage (LSE:SMT) is among the active funds.

‘The SIPP allows me to be riskier, but I do want to sleep at night’

Overall, he prefers investment trusts to open-ended funds. “The long-term performance of investment trusts tends to be better,” he says. “They are also more visible, in having annual reports to read through. And I find they are also cheaper than funds as well.” 

In addition to the ISA and SIPP, he has a cash buffer equivalent to around five years of forecast expenditure.

He says: “As I intend to access the ISA first, the SIPP allows me to be riskier. But I do want to sleep at night. I want to preserve wealth and not lose it, rather than attempting to punch the lights out.”

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Both the diversification in how he has structured his investments, and the cash buffer, help to keep a lid on risk. By having a separate cash pot, he says that “this protects [him] from having to sell investments if there’s a major market downturn”. 

He also intends to keep risk in check in future years by taking the income produced by the fund (the ‘natural yield’). This will involve switching from accumulation share classes to income share classes.

In a scenario where stock markets fall sharply, taking the natural yield from a portfolio helps protect the value of investments and allows them the chance to recover.

He says: “I will be aiming to take the natural yield from the ISA, but for any gaps, I can always sell fund units. By having five years’ worth of expenditure in cash, this will hopefully protect against any major market downturn.”

‘My views on active vs passive funds have changed’

While he has a mix of active and passive funds, this DIY investor is increasingly favouring the latter approach for its simplicity in providing the return of a stock market minus the fees levied, which tend to be low.   

He is not alone. There’s been a big shift towards passive strategies over the past 15 years. In 2007, before the financial crisis, the amount held in tracker funds was £29 billion, which at the time represented 6.3% of the total held in all funds. Today, there’s around £300 billion invested in total. This is about 20% of the funds industry, according to trade body the Investment Association (IA).

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He says: “My views on active versus passive funds have changed over the years. Active funds require dedication and time, whereas in hindsight I could have kept it more simple by just keeping the returns in line with the market with a passive fund. When you plot the performance of passive funds over five and 10 years, you can see the returns have been good enough.

“I am now questioning why I am bothering with active funds. Fund managers retire (or jump ship or are moved on), and investment styles go in and out of fashion.”

There are various factors influencing the popularity of simply buying the market through an index or exchange-traded fund (ETF), with one being that some investors are losing faith in the ability of active fund managers to outperform a comparable stock market. 

Sticking with Scottish Mortgage

Our investor looks to ensure that the active funds he owns are offering something genuinely different compared to what an index fund or ETF can offer. One example is Scottish Mortgage, which attempts to find exceptional growth companies, both publicly listed stocks and private firms (which amount to a maximum of 30% of the portfolio).

Scottish Mortgage’s short-term performance has come off the boil, due to its investment approach suffering in a higher interest rate environment. However, its long-term returns are stellar. Over 10 years, its share price total return is 320% versus 200% for the average global trust. Over one and three years, however, it has lost 18.5% and 18.0%.

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Our DIY investor says: “With active funds, I am trying to fill in what is missing from an index fund, while avoiding paying a high fee. Scottish Mortgage certainly ticks the boxes. It provides exposure that I won’t get in an index fund.” 

Our investor acknowledges that there are occasions when it is worth considering converting paper gains into real profits.

He says: “I am a buy and hold investor, but there are times when you do need to take profits. I took some profits from Scottish Mortgage when it had a really strong period of performance following the Covid-19 pandemic, but I kept most of it and I should have sold more. However, I am still confident for its prospects over a 10-year time horizon.”

Lessons learned as a DIY investor

While hoping Scottish Mortgage’s fortunes change for the better, one investment that will not see all the losses recovered is the fund formerly managed by Neil Woodford. It was not a huge holding, so while the losses were unwelcome, they were easier to stomach. 

He had formerly invested in Woodford when he worked at Invesco, prior to the former star investor setting up his own fund management firm. A lesson learned from the saga was that the “worst thing a fund manager can do is something different”, as opposed to sticking to the investment strategy in place. In hindsight, he says: “The fund was not doing what I bought it for.”

Other key lessons he has learned are to avoid panic-selling, as over time the stock market recovers its poise, and that timing the market is virtually impossible. 

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Our DIY investor also avoids investing in things he doesn’t fully understand. For this reason, he doesn’t invest in bonds, instead preferring to gain bond exposure through the index funds he owns and some of the active funds. “I would sooner leave bond exposure to the professionals, such as Capital Gearing and Personal Assets,” he says.

Finally, he stresses the importance of fund charges, which are one of the only things DIY investors have control over. Fees are central to the active versus passive fund debate, and, as our investor says, it is a question of whether “active funds reward [you] for the additional risk”.