Nobody ever told me the Great South Wall was that long! As the muscles screamed and the expletives flowed on my not-so-little run yesterday there was a fleeting moment when I almost quit. I wouldn’t have been alone on January 19th. Research conducted by Strava based on 800 million user-logged activities predicts this date as the day most people are likely to give up on their New Year’s resolutions. In fact, approximately 80% of resolutions are abandoned by the second week of February. Thankfully, the sun was shining and the brain cajoled me into accepting that this run was just one of a series of good habits to deliver a very productive 2020. Of course, the outcome is not a certainty but good habits vastly increase my chances. The same goes for investment goals.
Investment can be made to sound very complex. The professionals love complexity as it’s a perfect environment to sell expensive products and services to the least sophisticated clients. Whoodathunk there are more investment funds (75,000 at last count) to choose from than individual stocks globally? Yes, financial markets are complex but simple good financial habits can greatly increase investors’ chances of meeting their goals over time. We have previously written about the advantages of a portfolio approach versus the “lucky dip” dreamer derby so a portfolio of multiple investments is a sensible start. But what’s your goal?
The answer to this is entirely dependent on your age and your tolerance/capacity to suffer loss (even permanently). We shall assume for the purposes of this article the time horizon is 10 years and that the capital in this portfolio can incur some losses along the way and won’t be needed to fund living expenses over the period. No doubt readers are aware financial markets have had a good run over the past decade. It is entirely sensible to take the view that we must rein in our expectations for the next decade. Wall Street giant, Morgan Stanley, has already tried to manage expectations with its strategists suggesting a standard mix of bonds and equities in a portfolio would earn just 4.1% each year over the next ten years. Low-interest rates, low growth and commensurate low inflation are the familiar returns killers. Here’s the chart to anchor our goal expectations:
Now, let’s shift our attention away from the expensive large listed companies and all those bonds yielding zero or even less. In a previous thought piece, we wondered if smaller companies have some performance catch up to do on their much bigger listed peers. Holding that thought, we reckoned it might be helpful to illustrate the relative possibilities of assembling a portfolio of crowdfunding start-up opportunities over a four year period. So, here’s a suggested approach with plenty of good habits:
- Invest €100 in an equity crowdfunding campaign every month for 48 months (4 years). This good monthly habit avoids trying to “time” your entry into markets which will fluctuate over a long period.
- The portfolio goal is to own 48 equity opportunities in equal amounts of €100 by the end of year 4. This good habit of multiple holdings diversifies the portfolio across industries and geographies.
- A portfolio with multiple holdings also allows an investor to collect financial data across those companies and monitor various key metrics like sales, growth, cash flow/burn, margins, debt etc. Like all resolutions/habits – they are only sustainable if measured. This habit of measuring will ensure discipline and selection of opportunities which are consistent with the metrics/averages being observed. More on that again.
Good habits now in place, will the portfolio deliver? There are no guarantees in finance but here are a few suggestions as to outcomes and the understanding that the professionals think 4% per annum might be the best on offer over the next 10 years. We are suggesting a €4,800 investment of capital. We will assume that all target investments (48) benefit from a 40% tax refund under the EIIS investment scheme. After refunds of €1,920, investors’ are risking €2,880 in real terms. So that’s the capital at risk. We need to look at where the returns come from.
Readers will recall our previous references to the famous Arizona University research showing just 4% of all the listed stocks in US history have delivered the entire returns of the S&P 500 since 1926. In theory, and the sample size is small, it is possible as few as 2 holdings in a 48 constituent portfolio will account for the majority of returns. Now, remember Morgan Stanley is telling us a 4 year period might deliver a return on our capital of just over 16%. Here’s a table to suggest potential outcomes. We are going to assume the rest of the portfolio loses the equivalent of the tax refund(40%) ie 46 of the companies which received €4,600 in capital will lose €1,920 between them. Admittedly, this is probably too harsh an outcome but it will help illustrate what is required by just a few successes to beat a 16% portfolio return forecast on Wall Street. The following table lists a few scenarios and the impact of two companies achieving significant valuation growth:
Please note in the “2 Winners” column we are using €200 (€100 in each company) as the initial invested capital. Therefore a gain of €500 in the Match Wall Street scenario requires both companies to increase their value by just 1.5x. This is not a significant hurdle in the world of smaller companies and start-ups. The Run Wall Street scenario might sound fanciful equating to a 20x gain (or 2,000%) on the initial capital invested in the two companies. However, this is very possible in the world of private equity and startups. Yes, there is the risk of losing all your capital when betting on single winners but portfolio diversification is a very good strategy in a high-risk asset class.
Returns are inextricably linked with risk. That’s a fact and don’t ever buy any product which claims no risk involved. In the worked example above your total capital at risk was €2,880. For perspective, that equates to €15 per week of spend where the loss of capital is permanent – think almond cappuccinos, cars/taxis and mobile data usage on a weekly basis. Maybe take a walk with a bottle of H2O? What productivity goals wouldn’t prosper by ditching the screens, exercising and hydration…..
Finally, in the spirit of fresher thinking, it is worth noting the most unlikely companies can be the big winners so keep an open mind and spread the risk when building an investment portfolio. As an illustration and a little quiz, what’s the best performing listed stock in the US over the last 20 years? The clues would be that it features in a previous article and it delivers energy, but not the carbon-based kind! A real Monster which has delivered 87,000% returns over two decades. Wowzers! Good habits can really energize……
