Diversification Challenge

Some of us have been discussing the need to diversify more.

There are numerous tips on how to make sure that not all your eggs are in one basket. But they all assume that you have a great deal of time and a pretty sophisticated understanding of finance and financial services.

Like it or not, even with plenty of time on his/her hands, the 'man on the Clapham omnibus' is no financial giant.

So most people need diversification explained as simply as possible, and in a way that enables them to achieve it easily and conveniently.

What is diversification? The eggs in one basket idea is pretty simple, but needs some numbers: you are less likely to have all your eggs broken if you have 10 eggs in each of 10 baskets, rather than 100 eggs in one basket. Following this principle, you become automatically better off every time you add another basket for the same number of eggs. So you’d be much better protected against egg breakage if you had 5 eggs in each of 20 different baskets.

An interesting challenge would be to start with what a truly diversified portfolio of assets looks like, based on using a small amount of money. For argument's sake, one could start with a figure of £10,680 - the most the government allows you to salt away without locking it up til you're 98 years old, or paying tax on the returns.

But such government policy actually prohibits diversification, yet heavily subsidises regulated investments at the expense of alternatives.

That’s because most people with surplus cash should use up their tax-free allowances first, and few will have anything left over. Research cited by the Guardian in June 2011 suggests the average UK person can afford to save £97.10 per month.

The list of asset classes is long, yet the money allocated to those tax-free allowances can't be invested in the full range of potential assets, even by putting their money in the hands of managers who can invest more widely. Generally, you may only invest your tax-free allowances in regulated investments. And all sorts of rules, policies and other restrictions limit the types of assets in which regulated fund managers can invest. So even regulated fund managers are unable to adequately diversify the investment pots they manage. This must necessarily affect the value and performance of the funds they manage. Such effects may be market-driven and/or behavioural.

Then there's the tricky subject of asset correlations: if all the assets you've invested in behave the same way at the same time, then you aren't diversified. Apparently the correlation in the performance of assets has been increasing of late, but may be about to unwind in some cases.

First step along the way to meeting the diversification challenge should be to figure out a reasonably detailed list of asset classes. Then we should modify the regulatory framework to enable people to invest at least their tax free allowance in each of them. The list of assets can divide and divide, but I don't think we start out with a sufficiently granular picture. In reality, I think such a list might look like the following - note that I include different types of 'funds', and separate regulated from unregulated, because their performance can be affected by the differing levels of regulation and permitted classes of investments they can make. However, I'm not including instruments like spread bets, contracts for differences or futures, since these are merely contracts that get you exposure to the various assets. Am I right or wrong?

1. cash
2. savings accounts
3. fixed interest savings/bonds - government, corporate
4. person-to-person loans
5. shares listed on a regulated or 'recognised' exchange
6. shares not listed on a regulated exchange
7. exchange traded funds (ETFs) listed on a regulated exchange
8. ETFs not listed on a regulated exchange
9. regulated managed funds
10. unregulated managed funds
11. regulated hedge funds
12. unregulated hedge funds
13. venture capital funds
14. venture capital trusts
15. regulated funds of funds
16. unregulated funds of funds
17. commercial property
18. rural property
19. residential property (owner occupied)
20. residential property (buy-to-let)
21. perishable commodities (e.g. cocoa, wheat)
22. non-perishable commodities (e.g. oil, gold and other precious metals)
23. art
24. classic cars
25. fine wine
26. currencies

Diversify More

Great to see a broader debate about where social lending sits in the banking and investment world (most recently summarised on Bankwatch).

It would indeed be very helpful if people could deduct their social lending fees/losses against their income tax, and lend money to each other via their ISAs. Some day common sense will prevail.

Of course, you can already lend money to people (who aren't related to you) via your Self-invested Personal Pension plan with the trustee's consent. I explored that in some detail in 2007 while General Counsel of Zopa, and even obtained FSA authorisation for Zopa to introduce people to a dedicated 'mini-SIPP' that was to be issued by a SIPP-provider exclusively for lending money via Zopa.

On that basis, there's no reason you shouldn't be able to lend money to others through a 'DIY' ISA or stocks/shares component of your normal ISA, especially where the administration and audit-trail is outsourced to a social lending platform such as Zopa (currently the only one in the UK).

But let's go further.

The artificial distinctions between the various investment 'channels' merely confuse the issue of how diversified you really are, and create a needless multiplicity of intermediaries who all have to take their cut from our money. We know what it means not to put “all your eggs in one basket”, but struggle to see or understand the “eggs” and the “basket”, and unwittingly hemorrhage returns in fees and commission.

Consider that you can invest your money in exactly the same managed investment funds directly, as well as via a tax-free 'wrapper' such as an ISA, pension and/or child trust fund. And if your corporate pension is managed as opaquely as mine are, then you have no idea whether your corporate pension trustee has your pension money invested in the same funds you hold via other 'channels'.

As I've pointed out previously, figuring out whether your 10, 20 or 30 different funds actually represent a diversified portfolio, or ultimately all track each other, is no easy task. The existing product providers and IFAs can't really be expected to take a huge interest in your mish-mash of pension and non-pension, taxable and non-taxable investments (and let's not forget the mortgage albatross or any other liabilities you thought were assets). They tend to earn fees simply based on how much of your money they have 'under management'. So if your investments are scattered to the four winds, the revenue they earn from you is disproportionate to the work required to pull all the information together. In fact, it may not even be cost effective to pay the fees for an adviser to do a proper job.

While the FSA has reviewed retail distribution to try to resolve this issue, that review ignored any asset offered by a provider that the FSA doesn't regulate, including all consumer credit (and hence social lending via Zopa). The limited nature of the FSA's remit and resources prevent it from seeing the financial world holistically. Consider, too, that the FSA's own "MoneyMadeClear" website has different tabs for pensions, as opposed to savings and investments - when in both cases you're simply 'investing', and your money could end up in the same place through either channel.

As I've said before, we need a one-stop, low-cost service that allows you to track all your savings and investments, whether in or outside pensions, taxable or non-taxable; understand whether they're up, down or sideways; benchmark them against competing options; assess whether you are really diversified; avoid the pitfalls of transfer fees, dealing charges and other potentially hidden expenses; and cost-effectively trade your way out of any problems.

Remember, you are on your own: pay less, diversify more and be contrarian.

Personal Investing Made Easy?

My anxiety as a personal investor is rising at the same pace as world stock markets, unemployment, public sector debt and house repossessions. And the scale of the pension fund black hole actually seems to have induced one pension trustee to write to me for a second time in one financial year(!) - to remind me I can "change my investment choices". My gut tells me it's all going to get a lot worse and for a long time, before it gets better - and so does Bob Prechter, to name but one of many pundits:

I do my best to keep track of various small investments in numerous pots that have accumulated over the years - several ISAs, pensions (corporate, SIPP and stakeholder friendly) and child trust funds. I even move them around over the flames from time to time, in the hope that at least one or two will ignite. But none has yet paved the way to retirement, let alone a comfortable one.

So what changes should I be making to my investment choices?

The first step in any such undertaking is to figure out exactly what each investment is worth... and whether I'm ahead...... Or not.

And right there the whole personal investment management process comes to a juddering halt.

Because not all of the relevant information is in the one place, and some of it is downright difficult to obtain (when one confronts the different ticker symbols that pension providers use, for example). So there are always a few funds kind of drifting 'out there' that you learn about every 18 months from some forlorn pension trustee somewhere.

And figuring out whether your 10, 20 or 30 different funds actually represent a diversified portfolio, or ultimately all track each other, is no easy task for an amateur. In fact, the pension trustee who wrote to me recently didn't even suggest I try.

The product providers and IFAs can't really be expected to take a huge interest in your mish-mash of pension and non-pension, taxable and non-taxable investments (and let's not forget the mortgage albatross or any other liabilities you thought were assets). They tend to earn fees simply based on how much of your money they have 'under management'. So if your investments are scattered to the four winds, the revenue they earn from you is disproportionate to the work required to pull all the information together. In fact, it may not even be cost effective to pay the fees for an adviser to do a proper job.

The FSA has just spent oodles of time and money reviewing retail distribution to try to resolve this issue, and they've made some progress, but ultimately it seems an impossible task. Consider that the FSA's own "MoneyMadeClear" website has different tabs for pensions, as opposed to savings and investments - when in both cases you're simply 'investing', and your money could end up in the same place through either channel. And the FSA's review basically ignored any asset offered by a provider that it doesn't regulate, including all consumer credit - its remit and resources prevent it from seeing the financial world holistically. It's a fool's paradise, as I've pointed out before.

So let's face it: you are on your own. Pay less, diversify more and be contrarian.

Now I don't think I'm unrepresentative of a good many people over 40 who have a bunch of stray investments that are only going to grow in number, but not necessarily in size, and who know they really ought to be doing something to keep it all under control. I'm aware of services that go part of the way, but no one-stop, low-cost service that would allow you to track all your savings and investments, whether in or outside pensions, taxable or non-taxable; understand whether they're up, down or sideways; benchmark them against competing options; assess whether you are really diversified; avoid the pitfalls of transfer fees, and dealing charges that hammer nails into some apparently cheap options (e.g. I'm told not to trickle money into ETFs); and cost-effectively trade your way out of any holes.

All in a single afternoon.

But here are some examples of the elements that would be worth combining, even if initially that's in something like a Netvibes or iGoogle screen - other suggestions welcome - :

• FT.com - spend days finding the right fund names, ticker symbols and recording all your holdings using data from product provider web sites - remembering to record the trickle of reinvested dividends - and, hey presto, you can track the performance of your portfolio.


• Money Gym - hit the FT's gym to learn the basics of (some) asset classes.


• Yahoo's ETF Glossary - actually a useful repository of most investment jargon.


• Lower cost dealing - the devil's in the pricing detail, and you get no advice so have to know exactly what you're buying and why, but compare Motley Fool, The Share Centre, with those listed here.


• Comment and opinion from some top notch experts too numerous to mention here - not seductive stock tips (because I don't believe anyone should be relying on those unless they're sitting for 12 hours a day in front of 4 trading screens full of data to check them), but broader suggestions on how to view what 'the market' is doing, pitfalls, scams and so on.


• Books from said columnists and others who are aligned with helping you meet the real personal investment challenge.

It's a tough job, but surely one day someone will make personal investing easy.