Our previous lesson looked at adding funds to an equity-focused portfolio to help reduce volatility. Today's lesson covers how equities can improve a fund portfolio. Fund investors may be put off by the idea of choosing equities themselves. After all, many of them invested in funds precisely because they didn't want to do their own stock-picking: They want to keep their investing lives simple. But the effort involved with investing in equities directly can be worth it, for a few reasons.
Equities Can Add Oomph
Crocs, the makers of those popular rubber-like shoes you've been seeing everywhere over the past few years, did well for shareholders in 2007, for example, posting close to an 80% return. Try getting that kind of result from a fund. But before you get too excited, you should know that Crocs stock would have returned much more had it not lost 42% in the last three months of that year.
Whilst their success on this level hasn’t been enduring, the Crocs example illustrates how one strong-performing equity can add or subtract big money from your bottom line. Of course, that kind of performance is unusual. Expect barnburner returns on every equity you pick and you'll be very, very disappointed. But adding a few equities at the edges of your portfolio shouldn't damage the nest egg. And just maybe you'll be able to holiday in Norfolk Island, Australia--rather than Norfolk, East Anglia--in a few years.
Equities Can Cost Less
In these days of bargain online trades, it can cost less to buy a portfolio of stocks than it can to buy many funds. That's especially true if you're planning to buy two dozen or so large, steady companies and hold them for the next 20 years. You will pay the up-front trading costs and not spend another penny until you sell. Why pay a fund 2% per year in expenses to do the same thing?
In all fairness, plenty of large-company funds charge less than 2% per year. But if you had invested that extra money in large caps instead of giving it to the fund to buy and hold large-cap equities for you, compounding over those 20 years could have earned you a tidy sum on top of your initial returns.
If you have the resources, consider assembling a collection of two dozen or so stable, leading companies that represent a variety of industries to form the core part of your portfolio, with a plan to hold on to these names for years to come. You'll likely save on fund-management fees and, if you've put together a diversified portfolio of the largest UK companies, get market-like results.
You can then invest the remainder of your assets in funds that invest in smaller companies, foreign equities, and other styles that aren't represented within your core equity holdings.
How To Add Equities
Figuring out your appropriate equity/fund mix is--you guessed it--up to you. Begin by finding out how much you're paying for your funds, particularly your large-company funds. Do you have the resources to replace those funds with individual equity holdings?
Next, examine your fund's tax efficiency. Might you add equities to your portfolio to control when you realise gains and losses?
Finally, consider whether you'd like buy a couple of stocks at the fringes of your portfolio, just as a learning experience. Learn a little something about equities, and you'll understand your funds even better.
