How do you choose what to invest in? When it comes to stockpicking, there are all sorts of different tactics. One powerful – but ultimately rather dangerous – method is to put your faith in the brands you know.
It’s understandable really. For example, my grandparents have been shopping in Marks & Spencer since before I was born, and with the store still a ubiquitous presence on the British high street, it seems a solid choice. Of course the financials tell a rather less rosy picture.
According to a new study from Investec Wealth & Management, more than half of investors in the UK prefer to put their money into household brands, while nearly a third only invest in well-known firms.
It’s a common theme throughout the research. Investors feel more comfortable putting their money into companies which they are familiar with, where the understand what they do and how they make their money. And around half of the investors surveyed say that even if the shares didn’t perform well, they would stick with them anyway.
But building an investment portfolio dominated by household names can be a costly mistake.
Too many eggs in one basket
Sticking to big names will leave you with a seriously undiversified collection of investments. Think about the top brands that you are most familiar with, and they will tend to be found in just a handful of sectors – travel, retail and banking for example.
Focusing the bulk of your investments in these areas is fine if they are booming, but will leave you overexposed should they start to struggle. You might not be overly familiar with big pharmaceutical names or the top players in engineering, but if you are going to build a truly diversified portfolio you will need to have some exposure to those sectors.
Balance is far more valuable than familiarity.
The impressive unknowns
It’s not just a matter of spreading your risk though.
By focusing your efforts and cash on firms you know, you are overlooking potentially far better returns from the firms you are not so familiar with.
So if you are going to handle the stock picking yourself, it pays to do your reading. Look at where the fund managers are putting their money, and why. You don’t need to be on top of the prospects for the forestry industry in order to make money from the best performers there, profits which may dwarf those made from the same investment in a high street firm that you recognize.
You don’t really know them
This is a classic problem when it comes to investing. Because you recognise the brand, perhaps because you use their services often, you may feel that you really understand the firm and how it works.
This can lead to significant overconfidence, both in your actual understanding of how the firm operates but also its future prospects. You like using them, so everyone else will, right?
The truth may be rather different. Don’t be deceived by your own experiences – if you are going to invest in a firm, you need to approach it from a more neutral perspective.
Are funds the answer?
A straightforward way to address these issues is to invest via funds instead. That way it’s up the fund manager to put together a balanced collection of investments, removing any of your own personal biases from the whole process.
Or at least that’s the theory anyway. Again though it doesn’t always work like that, thanks to the growth of the ‘superstar’ fund manager.
Take Neil Woodford, the golden boy of the British investing scene. Seemingly everything he does is covered extensively in the financial press, which also gush over his impressive record. Because he has such a great track record, and he gets so much coverage, investors then fall over themselves to plow money into his funds.
But having launched two relatively similar funds recently – there is about a 60% crossover between the Woodford Equity Income Fund and the Woodford Income Focus Fund – there are now plenty of investors who have money in both unnecessarily, drawn by his star power.
Just as it is a bad idea to overcommit on brands that you have heard of, it’s a bad move to blindly follow investment ‘celebrities’ too.[“Source-forbes”]