I am what’s politely described as a ‘flexible organiser’. You can assume by that, that I’m not particularly organised, in addition I choose to use my organising skills mostly at work, where it’s more important. It means that I’m not very good at periodic tasks. I’m also lazy, really lazy. To compensate, I have pretty much everything set up as auto-magical.

automatic investing…

One of the things that is automagical is my investing. I invest through work in a stakeholder pension - exactly enough to get the match - and I also invest in a stocks and shares ISA. I use these financial products to save money in tax, but I just think of them as my investment accounts.

At the moment, I have £400 a month going into investments each and every month. I started my investment accounts with £70 a month when I got my first job.As you can probably tell, the amounts have generally increased over time, although I’m not sure whether that’s always been true, I could easily have taken an accidental break because I didn’t open a new account in time or something.

…takes a while to build momentum…

Money just rolls into the accounts every month, but I’m not yet at the stage where it’s built up into a massive sum of money. Off hand, I think I have in the region of £10k-£15k in my investments. That might sound like a lot of money, but I think I’ll need something in the region of £1m or more to retire. It can feel like it’s not really worth the effort - the money goes in but doesn’t seem to work for me.

The recent performance of the stockmarket doesn’t help. I’m primarily invested in FTSE All Share index funds, which over the past 4-5 years has been up and down massively, but is pretty much back where it started. 0% growth isn’t exactly what I’m hoping for long term.

…but when it gets going, it really goes

Fortunately for me, I can still remember the basics of mathematics. The power of compounding returns is really just an example of how exponential growth is so much larger than straight line growth. The money I’m putting away now won’t really work hard for me for another 10-15 years, but once it does it’ll just keep powering on.

And I’m savvy enough to realise that you can’t rely on the stockmarket in the short term, but chances are pretty good that you can in the long term. I’m still young, I’ve got just under 40 years until retirement and I’m confident that the stockmarket is most likely to be up over that period.

So, I’m going to keep going with my current plan. I’m about 20 years away from fundamentally needing to alter my investment strategy into a more conservative asset allocation. For me, investing is not fun, but it’s also not something to worry about. It’s more like brushing your teeth, something you do without particularly thinking about, because it’s going to be good for you in the long run.

They’re going to continue doing this in the future, but have decided to look at the range of actual returns on the products to pick the right range of numbers for growth. So, say currently they use 5%, 7%, and 9%, but actual growth is more between 2% and 6% over 10 years then they’d switch to using 2%, 4% and 5% in their marketing projections.

It all sounds very reasonable and sensible to me, but what was funny was that one of the new graduates is apparently doing a lot of the donkey work on the calculations suddenly realised that if (as is the case with many actively managed funds) the charges were 1.8% a year, and the projected return was only 2%, then the fund would have a 2%-1.8% = 0.2% actual return to investors. It would barely cover its expenses and certainly wouldn’t be a good long term investment.

Now, it’s unlikely that 2% is going to be a projected growth rate, but fees are really important when you’re looking at investments. They come directly off the growth of the fund, and you have to pay them regardless of whether your investment makes money or loses money.

As my friend quite rightly points out, there is no magic money cupboard. If you save or invest money with any company, they can only put the money in the same places that everyone else does - broadly speaking into bonds, shares, cash, property or commodities.

When you take out a pension, or an investment policy, or anything like that, you are really investing in bonds, shares and cash (and occasionally property or commodities). The value of bonds and shares can and will go up and down, and cash is at risk from inflation. If the whole stock market is doing badly, then it doesn’t matter who your investment is with, if there’s any component invested in shares that bit will be doing badly too.

People that look after the money you invest are clever, have passed lots of exams, and are genuinely trying to get the best return for your money. However, they don’t work miracles, and they aren’t likely to do much better than average because they have to work from the same information that everyone else does.

There’s no such thing as a risk-free investment, and nothing is immune from the major ups and downs of the markets. Understanding and accepting an appropriate level of risk are much better for you than mistakenly believing that the insurance policy you’ve taken out will make money come rain or shine because then, you’re taking on risk that you don’t even know about.

For those that don’t know, Equitable Life was an insurance company whose main business was in providing insurance/investment policies - things that as far as I can tell, are a combination of insurance and investment and used to be one of the preferred vehicles for saving and investing for retirement.

During the 1980s it offered Guaranteed Annuity Rate (GAR) policies, in return for regular investments each month policy holders were promised a guaranteed minimum return once the policy matured, and many people took these out planning to use them to supplement employer and state pensions in retirement. Equitable Life wasn’t the only company that offered such policies, many of the other large British insurers also did. . Projected returns were generally higher than are realistic today for all insurers, and Equitable Life’s were slightly higher again.

Returns on investments in the 1990s were not as great as in the 1980s, and the rates that the GAR policies were offering became unsustainable for Equitable Life. The management of the company assumed that it did not have to actually pay out the guarantee if there weren’t enough funds to do so, and sought a legal ruling to that effect in 1999. Unfortunately for Equitable Life, the High Court disagreed, effectively stating that a *guaranteed rate* meant that the rate, was guaranteed regardless of the insurers ability to make its total commitments.

The cost of losing the case was around £1.5bn, and the company has been effectively unravelling ever since. It closed to new business in 2000 and has gradually sold off most of its business to various other insurance companies including Prudential, Canada Life and Liverpool Victoria. Not only have the sales been dragging on and on, but there have been inquiries into what went wrong and several cases for compensation for different groups of policy holders.

Whenever you are managing investment money which has to provide an income you have to balance taking money out to meet your liabilities with ensuring that you don’t deplete the pot and risk being unable to meet future payments (you don’t for example want your pension pot to run out). It turns out that since around 1990 Equitable Life had effectively been taking too much money out to pay people whose insurance policies reached payout and not retaining enough in reserves to meet the promises it was making. In addition there were failures by the regulators and the Government Actuarial Department (GAD) to adequately check what was going on.

There doesn’t appear to have been any deliberate fraud going on; Equitable Life overused actuarial techniques in fairly common practice to justify their overstatement of their worth. Those techniques were judged to have been dubious by the inquiry into the debacle, and it also stated that “It is clear that Equitable’s returns were not understood by GAD actuaries throughout the 1990s” which sounds like a completely stupid idea.

What lessons does this have for the man on the street?

Well, the first thing I’d say is that when you take out an insurance/investment policy you are reliant on the insurance company accurately predicting how much money you are likely to have in the policy. It usually isn’t all that clear where the underlying investments lie, and I think that is not a good thing at all. I prefer to stick to basic investment funds - I understand how they work, and the risk that I am taking on when I invest in them.

My checklist for avoiding being a victim of something similar:

• understand how your investments work
• don’t put all your eggs in one basket - may as well use multiple different financial institutions
• if returns are better than others, then make sure there’s a real reason for this

1. Return = 500% Probability of Success = 33%
2. Return = 400% Probability of Success = 35%
3. Return = 600% Probability of Success = 32%
4. Return = 1000% Probability of Success = 27%
5. Return = 900% Probability of Success =28%
6. Return = 800% Probability of Success = 29%
7. Return = 700% Probability of Success = 31%
8. Return = 300% Probability of Success = 36%
9. Return = 1100% Probability of Success = 26%
10. Return = 1200% Probability of Success = 25%

Now, if you pick the investment with the best return - idea 10 - and invested your £100k into that, then if it works after 5 years you’d make £1.2m. Which is a lot of money.

On the other hand, if you diversify, and invest £10k in each idea, then the most you could get back (if all the ideas were successful) is £750k.

Diversifying dilutes the potential return.

It gets worse, because the although the probability of idea 10 succeeding is only 1 in 4, the probability of all 10 ideas succeeding is 0.00059% (to 5 decimal places). That’s a probability I’d describe as approaching 0.

So, invest all your money in the most lucrative idea and you’ve got a 1 in 4 chance of being a millionaire. Diversify amongst all 10 ideas and there’s an incredibly small chance of it all working and making you richer. But not a millionaire.

so why is diversification sensible?

Well, the key is in the probability of success.

If you invest in all 10 ideas, the probability that none of them will succeed is 3%, the return you’ll get depends on exactly which ideas are successful - it could be anywhere between £30k and £750k and it’s expected to be a little over £200k.

If you invest in only one idea, then no matter which one you pick, more often than not it won’t be the successful one. You might hit it big, but you probably won’t.

Diversification dilutes potential return, but it also dilutes the risk.

applying to real life

If you’re investing in a single company’s shares there’s a small but not negligible risk that it will be the next Enron, or Lehman Brothers, or Northern Rock. There’s a pretty good chance it won’t return the results you were hoping for.

If you diversify and invest in a whole basket of shares the chances that all of them will fail is much, much smaller. Certainly a whole lot smaller than the 3% of my example. And there’s a good chance that one or more companies will exceed expectations and that you’ll benefit as a result. This is why people use investment funds, as they pool everyones money to invest in a whole bunch of different companies.

Diversification is a poor way to get rich quick, but it’s a great tool for sensible investing.

Pick a stock, any stock.

Write a short investment article stating that the stock will increase in value over the next week.

Write a short invesment article stating that the stock will decrease in value over the next week.

Send each investment article to at least 1024 people, keeping a track of who received which article.

One week later, check what happened to your stock. Keep hold of the list of people who received the correct article.

Pick a stock, any stock.

Point out the correctness of your previous stock tip and write a short investment article stating that the new stock will increase in value over the next week.

Point out the correctness of your previous stock tip and write a short investment article stating that the new stock will increase in value over the next week.

Send each investment article to half the people on your previous list, keeping a track of who received which article.

One week later, check what happened to your stock. Keep hold of the list of people who received the correct article.

Repeat a further 8 times (so that you have sent out 10 sets of stock picks).

There will be at least remaining person who has received 10 good stock tips in a row. Offer them the opportunity to buy your stock picking system for a very reasonable price

Make up a stock picking system.

Sell it to them.

The beauty of the scheme is that it’s really hard for people to disbelieve you. For the one remaining person, you were right 10 times in a row. Why on earth wouldn’t you be right in the future? The fact that you were right by chance will probably escape them entirely, because they won’t know about the other, wrong, stock picks.

The way to really make it make money is to start with say just over 100,000 people. Then you’ll have around 100 people left at the end and you can probably several of them to buy your stock picking system. And make your stockpicking system an auto-subscribe thing. People always forget to cancel subscriptions.

By the way, I’m not sure whether or not the scheme that I’ve described is legal. It certainly isn’t ethical. But it’s something to bear in mind when you read great stock tips. It came into my mind when I received an unsolicited email about a stock, followed up a couple of days later by an email telling me that the stock tip had been right and giving another tip. I think I marked them as spam and moved on. I’m much more into sensible investing than unsolicited stock tips.

If investing in individual shares is the way you prefer to invest - and it can be sensible if you diversify well - then do your own research. If you can’t independently say why you think something is a good investment, then it’s not a good investment for you.

Johnny asked: “What’s the best investment for someone who has only $1,000?” Mr. Tobias said, “Nonperishable consumer staples.”

That reminds me of a story Howard Ruff tells about attending a conference years ago with a number of noted hard money advisers.

He got up to speak in front of 800 people and asked,”Do you honestly believe that in a period of monetary collapse that you will be able to safely drive down to your supermarket in your gas-guzzling car, make a selection from a dazzling variety of goods on the shelf, pay them with your personal check, walk safely out the door to your car, drive home and put them in your dependable, electric-operated refrigerator?”

He said that was the first time he ever got an ovation for a question! (Then he was able to give his advice about storing a year’s worth of food.)

But if I had to choose the overall best piece of financial advice I’d probably go with “Pay yourself first.”

I think that survival preparedness is a very American thing. It feels like only Americans would suggest that you need to stockpile food in your house in case there’s, well I don’t know what because some people recommend storing a years worth of food. A year! The longest anyone’s been unable to access food in the United States is probably a week or so in the aftermath of Hurricane Katrina, and then I reckon that most of the food in people’s houses would have been waterlogged.

but what about emergencies?

I understand the natural emergencies are real. In the UK the most likely emergency is flooding as happened in the Gloucestershire and Herefordshire last year, or Carlisle a couple of years ago and, floods like these are likely to recur. But think about what actually happens in such an emergency. Flood water comes in to the ground floor of the house pretty quickly. People are evacuated within a day or so usually in rubber dinghies and taken somewhere else. The flooding subsides within a fortnight. You might not get back home for months and months, but you aren’t in any danger of starving to death.

There’s insurance, and then there’s unnecessary insurance. In an emergency, people need food, shelter, heat and water. It’s the last of these that there are probably the fewest supplies of. There’s little point in having enough food to survive a nuclear winter if you have no available water. Or you’ll be suffering from hypothermia within a few hours. I’m not a stockpiler because I tend to just eat the food when I can’t be bothered to go to the shops, but if you’re going to do it it’s worth being consistent. Personally, I think that more than a few days worth (maybe a week?) of stored food is overkill. We just don’t live in that kind of country.

or monetary collapse?

The countries that I know have suffered severe monetary collapse have been post-Soviet Russia (early 1990s), post-WWI Germany (early 1920s), Zimbabwe (current). In each case the moment of crisis was caused by a political event or revolution - the collapse of communism, the loss of the war and the abdication of the Kaiser, land reform leading to the loss of production of the major cash crop. These are places that did not have robust or developed economies to start off with.

On the other hand, a comparison that is more plausible is the Argentinian collapse of the early 21st century. This led to riots, savings accounts and local investments were wiped out. People didn’t starve though. Argentina is recovering. The best hedge would have been to have diversified investments outside your own country, not a year’s worth of food in the basement.

in reality…

In the end, I guess that if you’re living on the edge, stockpiling non-perishables is not an awful idea because there’s a possibility that you won’t have enough money to buy them in the near future. If you’re worried about a natural emergency, then maybe a few days to at most a weeks worth of food would be enough, and don’t forget about the other necessities. Alternatively, do what I do and decide that the probality of needing to use the stuff in an emergency is lower than the probability of:

1. eating the stuff earlier because you’ve run out of food, or
2.  forgetting about it, and letting it go mouldy

And pay yourself first is great financial advice.

Here’s the funds Trent is talking about originally in Money magazine, together with his actual picks - note the heavy use of Vanguard.

1. A blue-chip U.S. stock fund - Vanguard 500
2. A blue-chip foreign stock fund - Vanguard Total International Stock Index
3. A small-company fund - Vanguard Small-Cap Index
4. A value fund - Vanguard Value Index
5. A high-quality bond fund - Vanguard Total Bond Market Index
6. An inflation-protected bond fund - Vanguard Inflation Protected Securities Fund
7. A money market fund - Vanguard Prime Money Market

Firstly, in translating for Brits, I’ll start by saying that there is no great equivalent of the Vanguard Prime Money Market fund. If you want a cash holding in your investment, they tend to be much of a muchness, and in any case you can usually do the same or better with a cash only ISA, or if you’ve already used up your ISA allowance, a high interest savings account.

I normally translate an S&P tracker (which the Vanguard 500 is) into a FTSE All-Share Tracker, the best (in this case definitely the cheapest) are the Fidelity Moneybuilder Tracker, in a Stocks and Shares ISA or stand-alone from Fidelity, or the HSBC Tracker in a pension from Hargreaves Lansdown.

A general international tracker suitable for a UK based investor is probably going to track the FTSE World ex-UK index. This avoids UK investments so is good for straightforward international diversification when combined with a FTSE All Share Tracker. The cheapest I’ve found is with Norwich Union.

The two bond funds that Trent has suggested are best matched by things that use these two indices FTSE-A Index-Linked All Stocks Index (inflation protected), or FTSE-A Government Securities All Stocks Index (all government bonds). Bond index funds are less common in the UK, the cheapest are usually with Legal and General, there are plenty of managed funds that have less than 1% in annual fees. I have to admit that this is on the edge of my own knowledge and I would defer to other people.

Finally, the small cap fund, and the value fund. I couldn’t find any index trackers for these. I’m afraid your guess is as good as mine as to which are the best funds. What you’re looking for in the small cap fund is one that invests outside the top say 200 companies in the UK, and for the value fund, I’d look at an equity income fund and check out its Morningstar style - it should say value. The UK fund market is notoriously uncompetitive on fees. In this area you’re essentially looking at an annual charge (discounted) of 1.5% for almost every fund. Good luck on that one.

In terms of asset allocation, the only major difference that you might want to consider between the UK and US, is that the UK makes up a smaller part of the world economy. This means that it’s arguable that you should diversify overseas more than Americans. Trent suggests 25%, perhaps considering that a minimum would be a good idea?

In general, the biggest difference between an American basic investing portfolio and a British one, is that it’s much more difficult to construct a cheap tracker-based British portfolio. Since I’m all about the trackers, I tend to stick to the FTSE All Share, and FTSE ex-UK trackers which are easy to come by, and leave the other sectors alone.

Sorry, I couldn’t be more helpful Llama, but I can’t really suggest good actively managed funds as there isn’t a clear way for me to tell them apart.

The allowed amounts are up to £3000 in a mini cash ISA, up to £4000 in a mini stocks and shares ISA, and up to £7000 in a maxi ISA (basically stocks and shares).

For a while now, I’ve had a trickle of requests for a basic guide to investing in UK Stocks and Shares ISAs.

Previously on the basic guide to Stocks and Shares ISAs:

• introduction – what is the basic guide to Stocks and Shares ISAs about
• part 1: all about you – why you want to invest, and how much money you have to play with
• part 2: all about risk – successful investing means always being able to sleep at night
• part 3: all about investments – what types of investments that you can put into ISAs
• part 4: all about asset allocation – how to decide which mix of investments is right for your ISA
• part 5: all about funds – narrowing down your choices
• part 6: all about providers - getting the best deal for your money

what have we done?

If you’ve been following the series, you should be able to work out how best to invest your Stocks and Shares ISA allowances for 2007-08 and 2008-09.

We’ve covered your goals and timescales for your money, and the amount of money you have available. We’ve then talked about risk and the things we need to consider when relating risk to investments - especially asset allocation. We’ve also covered funds and providers that you might be interested in using to create your asset allocation.

If you use the ideas and tools in the guide, you will be able to make a reasonable attempt at defining your investment plan for your stocks and shares ISA, and a reasonable attempt is probably good enough for now. You should know what you want to invest in, and a pretty inexpensive way of doing so.

what next?

Open a Stocks and Shares ISA account with your chosen provider. If you know what you want to invest in (and I’d suggest that you don’t open one until you do) then it’s no more difficult than opening a bank account. Just remember to have the names of the funds and the percentages you want allocated to each written down correctly.

You can usually set up a direct debit or standing order if you want to invest monthly, or you can generally do a bank transfer or send a cheque if you’ve got a lump sum to invest.

Investing doesn’t have to be hard, and to a certain extent you can “set and forget” but just as regular shopping around for the best savings accounts will earn you more interest, keeping an eye on your investments intermittently will allow you to manage them better.

The most important thing to keep your eye on is your asset allocation. Different funds will grow at different rates so your investments will veer away from the percentages that you initially set up. This is ok, all you need to do is rebalance selling what you have to much of, and buying what you don’t have enough of. Rebalancing is one of the easiest ways to make yourself buy low and sell high - the surefire way to investing success. 

The final thing is don’t forget that if your investment goal has a specific timeframe associated with it (like school or university fees) then you probably want to start “lifestyling” it, and changing the asset allocation about 5 years out.

If you’ve got any more questions about Stocks and Shares ISAs, please let me know in the comments below.

PS The tax year 2007-08 ends on 5th April 2008, so if you haven’t used your Stocks and Shares ISA allowance yet, you need to get cracking on with it.