In light of the very disappointing total loss on our Conviviality tip, on which we published an update here a week ago, Questor feels that we should set out how we expect our stock selections to be used.
Several readers have been in touch to describe the very severe losses they have suffered and it is clear that some had taken large bets on this one stock. This is most definitely not how we want our tips to be acted on.
When we say a stock is a “buy” we mean that we have good reason, based usually on the opinions, and more importantly the actions, of professionals whose job it is to scrutinise stocks, to expect the price to rise. But nothing is certain in investment and even the most experienced, intelligent and well-informed professionals can have their expectations confounded by events.
In fact, fund managers sometimes say they are doing well if 60pc of their holdings make money.
Faced with these odds, we urge readers never to follow individual tips in isolation. Instead it is vital that investors protect themselves against the risk of severe, even total, losses of money by the most potent protective medicine in investment: diversification.
So if you are a new Questor reader and have read a column you believe makes a convincing case for buying a particular share, by all means act on it – but in such a way that the stock forms part of a portfolio of shares and does not become the sole home for your hard-earned savings.
Let’s imagine you have £100,000 to invest for your retirement. You read a convincing case in Questor, or elsewhere, for buying a particular stock. Whatever you do, no matter how strongly you believe in that stock, do not commit your entire £100,000 to it.
Instead limit your purchase to £10,000, or ideally less, and continue your stock research until you have identified another nine shares, or more, into which you are equally happy to commit your money. In other words, spread your cash among at least 10 shares and preferably nearer 20.
These shares should not include more than a couple that are particularly risky or speculative, normally labelled as such in this column. Aim to own companies that operate in a variety of sectors and are exposed to different aspects of the economy.
The best proof of the power of diversification comes from looking at Questor’s Inheritance Tax Portfolio, of which Conviviality was a part. As we know, anyone who put all their money into the drinks firm has made a 100pc loss. But an investor who split their money equally between the 13 stocks in the portfolio has to date made a loss of just 1.7pc.
Despite Conviviality, the IHT Portfolio has outperformed the FTSE 100 index by 2.8 percentage points.
The only time you should feel free to disregard the advice above is when you are committing sums small enough to be regarded as punts. An investor with £100,000 in total might feel comfortable putting £1,000 into one stock on the basis that if it does go bust the loss is bearable.
But for serious investors who intend to commit the bulk of their life savings to stocks, diversification is essential.
If you do want to put serious sums into the stock market but do not wish for any reason to do the work necessary to identify the 10 or more stocks needed for a prudent level of safety, invest your money in funds instead. We recommend an investment trust, a fund listed on the stock market, in this column every Thursday.
Had you put all your money into one of Questor’s investment trust selections, the worst loss you would have suffered is 27.9pc (and that tip was labelled as “more risky than many”). As the trust remains in business, there is also the chance of recovery.
It is still better to invest in a selection of funds than commit all your money to one, but the latter course is much less risky than it is with individual shares.
Anyone who has already put large sums into one or two of our stock picks is advised to sell the bulk of those holdings as soon as possible and reinvest the money in several other shares so as to build the kind of diversified portfolio outlined above.
Finally, remember that even with a portfolio of stocks there is still risk – the entire market could fall severely, for example. Be prepared to hold your stocks for enough time to ride out the ups and downs.
If you are not able to accommodate these risks, do not put money in the stock market.