FOOL'S EYE VIEW
Building a Long-Term Portfolio

By Stephen Bland (TMFPyad)
July 23, 2001

This article is supposed to be subtitled "How much should I invest and where?" which strikes me as one of those "how long is a piece of string?" questions, the answer to which alters radically depending upon means and the degree of risk that the investor is willing to take.

Generally, as readers will know, the TMF view on investment tends strongly towards equities. Despite my disagreement with a lot of things around TMF I support that overall concept wholeheartedly and have been putting my money where my mouth is for most of my adult life.

There are, of course, other types of risk investment that can prove rewarding, the most common of which is property for those with the means to finance such investments. I am thinking here of second and further investment properties rather than one's own place, although even the purchase of a property for your own residence could be considered an investment. This might be the case if you intended to trade down to something cheaper in the future, for example.

I will concentrate in this article not on the wider aspects of investment or the types of investment to select --asset allocation as it is sometimes known -- but on equity portfolios alone. Having said that, though, I believe firmly that people should first buy themselves a property in which to live, and then start looking at shares as a savings vehicle.

Starting at the lower end of the investment scale, suppose you have only a few quid a month to save. It would be pretty difficult to build up much of a share portfolio for £50 or £100 per month. The obvious answer then is some sort of fund. But if you go for a fund you have to understand that these generally involve a long-term commitment and that broadly based, non-sector-specialised funds do not exhibit the kind of performance that is likely to make the proverbial killing. In other words you are not going to make terrific returns. In fact you could invest for years and get nowhere or lose money which is what has happened to index tracker funds over the last three or four years. So if you go the general fund route, perhaps a tracker or another kind of fund that can be rewarding, a higher yield equity fund, be prepared to stick with it for five to ten years minimum and realise that you are not going to end up rich by doing so. But this approach will likely do better in the long term than other forms of collective savings such as endowment policies or a deposit account.

If you have more money to invest, then even so you may be advised to stick with a fund. I would agree with that advice for the investor that has little interest in the market. But if you do develop an interest then you may be ready to consider individual shares. We are talking portfolios here, not people who wish to trade shares short-term. The word portfolio implies a long-term hold strategy, in my mind. Not necessarily never trading the shares at all, but in general sitting on them for fairly lengthy periods with perhaps an occasional review. I am assuming also that we are talking about a growth portfolio rather than one upon which the investor depends for income. Having said that, though, there is plenty of evidence that shares selected for income can in fact produce quite decent growth as well over the long term by reinvesting dividends.

So how you should you select a long-term portfolio? As a general guide, whatever other criteria you use to construct it, I would advocate two basic principles.

First, ensure that you spread your money across sectors. A little concentration may not be a bad thing so I am not necessarily suggesting that every single share should be from a different sector, but it is essential that a number of sectors are represented. The reasons are probably fairly obvious. Security of capital is vital for this strategy and consequently by sector diversifying you reduce the effect of any major problems affecting one particular industry.

Secondly, stick with large caps -- say, FTSE 350 companies only, that is, the 350 largest companies in the UK market. That takes you down to a capitalisation of a few hundred million pounds at the smallest. The reason is really the same as above, security. I believe that larger companies are less likely to go broke than smaller ones.

Those are the basics of a long-term portfolio, my style. There are many other more personal ideas that some might adopt in addition. For example, I would always exclude any company in any new, single product type field which in the current market would be tech and certain specialist biotech shares. That means leaving out companies like ARM Holdings (LSE: ARM) and Autonomy (Nasdaq: AUTN) in which I have not the slightest faith whatsoever. The reasons again are as above, security. The chances of this sort of share doing the business for you long term are so slim that in my opinion they are not worth taking.

Note that you don't need a very large number of shares to attain a fair spread. Fifteen or so is perfectly adequate to diversify the sector risk.

Finally, don't try and guess what will happen over the very long term. If you think, say, twenty years hence, nobody has the remotest idea. Don't listen to anyone who tries to tell you what the future might bring, especially "experts". I recall, for example, way back in the Yom Kippur War of the early seventies and the major financial crisis that followed, with probably the greatest bear market ever, some expert telling me that oil companies were finished.

And that's it, really, on portfolio construction. It doesn't require that much thought, given the completely unknown future into which you are investing. Just a decent spread of blue chip type shares. And if you don't know how to begin, you could do worse than simply working your way down the FTSE 100 mechanically, picking one or two shares from each sector until you have sufficient for your design.