Chapter 8. Other Ways to Invest

Passive investing

There is no doubt that so-called passive investments, in the form of index funds and exchange-traded funds (known as ETFs), have become a lot more popular in recent years. We can see that on the daily traffic on the Hargreaves Lansdown website, where we now publish regular research on both index funds and ETFs. (The key difference between the two is that the former can only be bought and sold once a day through the issuing company, while the latter can be bought and sold throughout the trading day in the stock market, just like shares.) The number of markets and sectors that are now covered by passive funds has grown enormously in the last 20 years, which if nothing else is good for choice.

While I don’t own any myself, I would never say that passive funds are to be avoided. A broad market index fund can be a good starting point for a first-time investor looking to gain exposure to the UK or world stock markets. Until or unless you have confidence in your ability to pick the best actively managed funds, buying a plain vanilla tracker fund is the simplest and most efficient way to make a start as an investor. If you do buy an index, or tracker, fund, your first objective is to find a suitable index, such as the FTSE 100 or All-Share index. Next you need to make sure that the fund actually does what it say, namely track its benchmark index as closely as possible. Surprisingly, not all do that job that well. It can be an effort to find out what a fund’s so-called ‘tracking error’ is, but it is an important piece of information. (Tracking error is measured as a percentage, and you are looking for a fund with a tracking error of less than 0.25%.) Index funds generally work best when tracking an index in the world’s biggest, most liquid, stock markets.19

Assuming that they do the tracking part well, the objective then is to pick the funds that have the lowest charges, just as you would with any other commodity, which is what tracker funds essentially are. Costs are usually the biggest factor in determining tracker fund performance. Some of the core UK tracker funds we suggest, where HL is able to use its buying power to negotiate a particularly attractive price, have ongoing charges of less than one tenth of one per cent a year. For funds that track the main indices in big overseas markets, such as the S&P 500 index in the United States, or the Nikkei or Topix indices in Japan, the charges are typically somewhat higher, but still reasonably competitive.

It is worth making the point that the more exotic the index being tracked, the higher the charges become and the more of a drag, invariably, those charges will impose on performance. The higher the charges, the more certain it is that those funds will fail to meet their own declared objective of matching the performance of the stock market they are seeking to replicate. Some of the earliest tracker funds that were launched in the UK back in the 1990s had shockingly high annual charges of 1% or more. If you do the maths, over a period of say ten years a fund with that level of charges is guaranteed to underperform its benchmark by a cumulative 15%, even if it tracks the index perfectly! That is money that comes straight out of your pocket and is a long way from being the market-matching return that you might have thought you were being promised.

One technique that tracker funds use to offset the adverse impact of their charges is a practice known as stock lending, where a fund lends its holdings to a third party in exchange for a modest fee. That brings in some useful revenue and helps to reduce the tracking error, but it also creates some additional risk. I would only recommend a fund that lends stock if the investors see the benefit in the form of lower fees and the risks are clearly disclosed and carefully managed. You need to make sure that you know whether your tracker fund is stock lending or not.

The argument for tracker funds is that they can be a reliable way to achieve better returns than the average fund in their sector. If the majority of actively managed funds underperform their benchmark, a tracker fund that actually does its job of replicating the performance of its index must, as a matter of definition, finish in the top half of the performance tables. If you are worried about the risks of losing money, that may be an important consideration. But if you think of fund performance being like football, even the most effective trackers will always be Championship rather than Premiership teams – decent, solid performers, but always in the second tier, not the first.

The question then is: why settle for second best if you can have the best? If you believe, as I do, that in-depth research and years of experience can help you identify the best funds in their sector, the case for picking actively managed funds is clear. Of course, actively managed funds do better in some markets than others – the US market has proved a particularly hard market for active managers to crack – but the only fundamental advantage of a tracker fund for most investors is that it eliminates specific fund manager risk. They can be a perfectly reasonable choice for investors who either prefer not to do their own research or don’t feel qualified to assess fund manager risk. As they should always have cheaper running costs, you do at least have the certainty of knowing that you are getting what you pay for – something that by definition is never the case with actively managed funds.

It is worth pointing out that not all ETFs are quite as simple or useful as the conventional index-tracking funds of the kind that I have been describing. There are actively managed ETFs as well as passive ones. Some of the more esoteric ones may, for example, be offering you the chance to make a leveraged bet on commodities. They can be extremely dangerous instruments that can easily lose you most of your money if the markets they are following go the wrong way. So it is important when looking at the range of ETFs to make sure that they really are what you think they are. As a general rule ETFs are in practice mostly used by traders who are speculating rather than investing in the traditional sense of the word. You should leave that kind of thing to the professionals.

Investment trusts

I have not said a lot so far about investment trusts, although I do own one or two myself (as you will have seen in the chapter on my personal portfolio) and they are in some respects an ideal investment vehicle for the DIY investor. Many of the principles of investing I have discussed in relation to unit trusts and OEICs apply equally to investment trusts, but it is undeniable that they are slightly more complicated and harder to explain, which can be a deterrent. While I have tried to spare the reader too many definitions and explanations, as they can easily be found on the internet, you will have to excuse me for going into slightly more detail in this section.

How investment trusts differ from unit trusts is that they are (a) closed-ended and (b) trade on the stock exchange. This means that to start life they need to raise money through a public offering of shares (an IPO, in technical jargon) and this gives them a fixed amount of starting capital. Unlike unit trusts, which create or cancel units at will, they can’t grow or reduce their assets anything like as easily as a unit trust can.20 The net asset value of an investment trust generally rises and falls in line with the market and the expertise of the fund manager. Consequently, whereas the price of a unit in an open-ended fund should nearly always track its net asset value very closely, this is not so with investment trusts, whose share price is influenced by supply and demand.

If the trust is in fashion, or performance is stonkingly good, the shares may stand at a premium to net asset value. If you buy shares in the trust in these circumstances, you will be paying more than its current assets are worth. If on the other hand demand is poor or non-existent, and performance has been indifferent or worse, the trust’s shares may well slip to a discount. The share price will then stand below the net asset value of the trust; now when you buy the shares, you will be paying less than the underlying value of its assets.

Got that? I can assure you that it isn’t as complicated as it sounds. In simple terms, buying shares in an investment trust when they are at a discount is broadly a good idea – akin to something being in the January sales. Buying at a premium, however, certainly if it is more than say 3% to 5%, is usually a poor idea in the long run. There are some nuances behind this simple formula however! It depends a lot on why the discount has come about. If it is because the fund manager is no good and the trust’s performance reflects that, the case for buying is weak, even if the price is a bargain basement one. But if it is because the whole sector is unfashionable, unwanted and unloved, it can often be an indication of genuine value and you should investigate it as a potential buying opportunity. Even in the first case, it may be worth keeping an eye on the trust as the board of directors always have the power to change the fund manager for someone better. If this happens, you will tend to see the discount start to narrow, though rarely immediately, which may still give you time to get on board.

When a trust is trading at a very large premium, it may be because the fund manager is exceptionally good, or more often it is an indication that the sector the trust invests in has become highly fashionable and therefore at risk of a sudden or dramatic change in sentiment. When a trust is trading at a premium of over 10%, it strongly suggests to me that you should not be buying it. It really has to go some in order to justify that kind of fancy rating. Even top-quality fund managers can see shares in their trust go from a premium to a discount. In those cases, however, they can often go back to a premium again, so keeping a watching brief on the share price and discount can be worthwhile, since from time to time it can throw up attractive opportunities.

One of the best examples of that phenomenon over the last five years has to be the case of Fidelity China Special Situations, which nicely illustrates a number of issues I have already mentioned about the difference between good and bad funds. In this case the story includes one of the UK’s best fund managers, a sector that has drifted dramatically in and out of favour, and the impact of huge media exposure. The trust was born when Anthony Bolton, who had successfully run unit and investment trusts for Fidelity for more than 25 years, decided after a brief retirement that he wanted to move to Hong Kong in order to run a China fund for his old firm. Given his track record and high profile in the industry, coupled with the popularity of China as an investment theme, the launch of his new investment trust attracted a record amount of money, more than £500 million.

Initially the fund performed well, and before long was trading at a premium of more than 15% to net asset value – a classic example of a warning bell sounding. What happened next was that the Chinese stock market started to perform less well, and a couple of Mr Bolton’s core stock selections turned out badly (one of his companies being accused of fraudulent accounting practices). Given his high profile, these problems inevitably hit the headlines in a big way. The fund slipped from a premium to a discount and, worse still, the share price fell as far as 70p, well below the issue price of 100p. The media was full of stories that Mr Bolton was unable to transfer his skills from the UK to China. Some gave the impression that he was over the hill and had lost his way. Many private investors expressed their disappointment by selling their holdings at between 70p and 90p a share.

By the time Mr Bolton retired from running the fund in 2013, the media was still largely hostile, some going so far as to imply that his time at the helm had been a failure. Although performance had already improved, the shares at that point were still trading on a discount of 14% to net asset value. Yet as the following chart shows, the reality was that he had beaten the fund’s Chinese benchmark while he was in charge, which hardly justifies being called a failure. More to the point, he had already laid the seeds of a high-return stock portfolio. Since then the portfolio has blossomed under Dale Nicholls, its new manager. The Chinese stock market then recovered strongly, with the result that five years after launch shares in the fund stood at around 170p, more than double its price at the earlier low point.

Figure 6.9: A matter of interpretation – the track record of the Fidelity China Special Situations fund.

Those who sold out after the initial disappointing performance missed out on a chance to make a 70% gain. This neatly illustrates the fact that you shouldn’t believe everything you read in the media. A little time spent in research would have suggested that the move to a big discount was actually a classic buying opportunity, not a sell signal. Given that any equity investment should be seen as a long-term project, it was a mistake for investors to sell after just two years of experience, however disappointing the ride had been. The other point is that the Fidelity China Special Situations story illustrates how investing in investment trusts can be both more hazardous and more rewarding than investing in an equivalent unit trust, precisely because of the discount/premium cycle. It takes more work and more courage to invest this way – whether that is for you is a matter only you can decide.

Another important difference between investment trusts and unit trusts is that investment trusts can ‘gear’ their returns in a way that unit trusts cannot. What this means is that, if the board of directors agree, the trust can borrow money in order to boost the amount of capital that they have to invest. If the fund manager can make a greater return with this extra capital than it costs to borrow the money, the trust and its shareholders will be better off. (To continue the driving analogy, they have moved up a gear or two.) The scope for gearing is another factor that makes analysing investment trusts more complicated as the decision to gear or not can make a significant difference to investment performance. It also adds to the risk of share price volatility.

Each trust makes its own decision, adding to the diversity of returns. Some investment trusts never gear, believing that their portfolio is already risky enough. Gearing can work both ways. When interest rates were much higher than they are today, many trusts mistakenly geared up by borrowing at a fixed rate, in some cases locking into permanently high borrowing costs. With the march of time this problem has gradually unwound. In a world of very low interest rates, as we have today, gearing does appear to make more sense. The effect of gearing means that investment trusts in general outperform their unit trust equivalents when prices are rising in a bull market, but are certain to suffer disproportionately the next time the stock market takes a tumble. Care therefore needs to be taken when comparing unit trusts and investment trusts. In the main, the last few years have been good to investment trusts, as they have had the double benefit of narrowing discounts and gearing. It will not always be so.

Should you be put off by the greater complexity of investment trusts? I don’t think so, although it does obviously depend on how much time for research you have at your disposal. Potentially investment trusts are a rich feeding ground for the self-directed investor. There are plenty of pricing anomalies you may be able to exploit. One reason is that professional investment institutions, which once were big buyers of investment trusts, have steadily divested their holdings over the years in favour of managing their investments directly. In a market dominated by individual investors, pricing anomalies do not always disappear as quickly as they would do in the professional institutional market.

In my view their complexity means that investment trusts will never be mass market investment vehicles in the same way as unit trusts were designed to be. That is actually a good thing. If they were to become more broadly owned, it would remove most of the advantages that private investors enjoy with them today. The very first investment trust, Foreign & Colonial, was formed as long ago as 1868. Despite its long illustrious history, after more than 150 years it is still only capitalised at £2.5 billion. By contrast, in the few months since Neil Woodford launched his most recent unit trust in 2015, it has already attracted more than £6 billion of investors’ money. Now that is what I call a mass-market product – simple, easy-to-own and simple to monitor. Investment trusts will never be that, but they do have other advantages instead.

You will see in the media that financial firms are often criticised for not recommending investment trusts more frequently. There is a simple reason for this. Many investment trusts are quite small and that makes it difficult for firms with large numbers of execution-only clients to suggest them. The reason is that buying and selling shares in many investment trusts in size is difficult. The top 20 largest trusts rarely trade more than £2 million in a day. This won’t matter to a DIY investor who is looking to buy or sell between £1,000 and £10,000 of trust shares, or to advisors who can spread client orders over a period of time. But for a firm like ours with thousands of clients, recommending an investment trust could suddenly swamp the market with buy orders, something that could never happen with a unit trust.

Just suppose we recommended an investment trust through our newsletter. What might happen? The market makers, the professional firms that take and implement buy and sell orders, would see the recommendation and mark up the price of the trust before the orders came through. Buy orders on any significant scale could not all be fulfilled, leaving clients frustrated. Worse still, the clients might want compensation for failing to have their orders fulfilled, particularly if that price continues to move up. If our advice was to sell, then the problem would be even more acute. This is why platforms offering execution-only services are wary of investment trusts and is why I also think they are generally unsuitable for the mass market.

That does not mean they might not be right for you. If you can get to grips with understanding how investment trusts work, they can be an attractive way to invest. They can still help you even if most of your money is going into open-ended funds. (As explained in the previous chapter, I own shares in RIT Capital, in part because there is no open-ended alternative.) The premium or discount at which investment trusts trade can also be extremely useful in seeing how investor sentiment is moving. It can be a good indicator of whether a particular sector or market is on the cheap or expensive side. If many more trusts are trading at premiums, it may be flagging up that we are near to a market top, while large discounts across a number of sectors suggest the opposite.

Venture capital trusts

Venture capital trusts are another sector in which I have been able to invest profitably in the last few years. What is a VCT? Well, as its name suggests, it is an investment trust that invests in venture capital – in other words, providing capital for new or established businesses that need cash to develop their business, and are typically either too immature or perceived as too risky to be able to borrow that money from a bank or other commercial lender. Anyone who has watched Dragons’ Den will know how many would-be entrepreneurs find they need both finance and professional expertise to get their fledgling businesses off the ground. Since the financial crisis, banks have been cutting back on their lending to small and medium-sized businesses and venture capital investors have stepped in to help fill the gap. As an investor in a VCT you effectively get a return from both the lending and the equity investment that the manager of the trust has made.

Managing a VCT – picking the right businesses to back and helping them to grow – is a specialist form of investment management. Most of the firms which offer VCTs are small boutiques that are independent of the big fund management companies such as Fidelity and Aberdeen Asset Management. Nurturing new and growing businesses is an important function in any capitalist system and governments of all political persuasion have traditionally tried to encouraged it by offering tax breaks for those who invest in them.

When I started out in investment the main form of tax incentive was called the Business Expansion Scheme, and it wasn’t frankly a great success. Many of the businesses that were backed under this heading were rubbish – more Del Boy than Google – and the charges were quite high. Since then things have evolved a fair bit and today VCTs have become a valuable source of finance for new companies as well as a useful additional home for any spare cash you are lucky enough to have as an investor.

That is because each VCT will invest in a diversified portfolio of companies, some of which will work out well and some will not. With luck the successes will more than outweigh the number that for whatever reason fail. Because they are young and risky, start-up businesses can grow very quickly if things work out and you only need a handful of those to produce overall gains in a diversified, professionally managed portfolio.

Admittedly VCTs are most suitable for those who are lucky enough to have already built up a sizeable amount of savings or are close to using up their lifetime pension limit. Because of the importance that the government attaches to venture capital, the tax breaks can be very valuable, especially for those looking to generate more income from their capital. The main benefit from investing in a VCT has been that your initial investment can be set against tax and will normally give you a tax rebate equivalent to 30% of the money that you have invested. Thereafter any dividends you receive are free of income tax and there will be no capital gains tax to pay when you sell them. The tax relief is withdrawn if you fail to hold the shares in the VCT for at least five years21.

As with an ISA, another benefit of investing in VCTs is that you don’t have to bother including the dividend payments on your annual tax return. The main attraction to me, apart from knowing that money I would otherwise pay in tax is going to help small businesses that the banks won’t touch, is the tax-free income which I know I will need and appreciate when I am older. Assuming that the government does not change the rules about what qualifies for the favourable tax treatment, I expect to be adding to my VCT portfolio for the next few years. My main complaint about VCTs is that their fees can be quite high. Many also charge a performance fee in addition to their annual management fee, a practice which I have never liked.

It is important to remember that the tax breaks only kick in if you buy shares in an initial fundraising, not when you buy them in the secondary market. Because they are illiquid, the prices in the secondary market tend to be volatile. During the financial crisis, a lot of VCTs went to big discounts of 30, 40 or even 50%. As an existing investor, all you can do is sit through those episodes, but if you are on the ball it can sometimes be worth buying more in the secondary market at those heavily discounted prices. Although you don’t qualify for the initial tax relief, you still get the tax-free dividends and the prospect of capital gains on top as the discounts reduce over time.

My VCT portfolio includes funds run by the likes of Northern Venture, Maven and Mobeus. Some VCTs are quite specialised and I prefer to stick with the generalist ones, rather than say the AIM VCTs which invest mainly in quoted stocks in the AIM market, where you always have the option to buy the unit trusts that do the same thing.

By the nature of the business the payouts from VCTs can be quite lumpy. If you are lucky and your VCT has a spectacular success, you may get a special dividend as well as regular interim payments. A good recent example was when Octopus sold its stake in Zoopla, the online estate agent portal it had funded. Because they are more risky, I take a long-term view of my VCT holdings, as you have to do. However, my experience is that VCTs are not as risky as some people seem to think. By and large they are fantastic dividend payers.

The main problem is that VCTs can be difficult to analyse; they are mostly run by teams, and telling the good ones from the bad is not easy. The liquidity can be poor, so selling at the price you want can be difficult. Many VCTs trade at a discount to their net asset value (and the rules and tax reliefs keep changing, which I am afraid is an occupational hazard). However, it seems to me, looking back over the 20 years or so that VCTs have been around, that half a dozen or so companies have emerged from the pack as the best of the breed and rather than trying to cherry-pick the best ones, I aim to hold a cross-section of the proven performers.

Buy-to-let is not all it is cracked up to be

Technically buy-to-let is outside the scope of this book. Yet property has become a near religion in the UK. For many it is the asset class that never fails and it is certainly true that property has turned out extremely well for many. But for me property has always been about a place to live rather than investment. I don’t even think of it as an investment, at least not in the case of buy-to-let, which only really started being a private investor option in the mid 1990s. Buy-to-let is really a business venture, not an investment; the two are very different.

It would be silly of me to suggest that buy-to-let isn’t something to look at. But you should go in with your eyes open. I notice, for example, that its fans tend to place its origins in 1996, which was right at the bottom of the then property cycle, and give all sorts of statistics to prove how well it has done against all other asset classes. It is perfectly true that it has done well since that date, but as I have said elsewhere in this book, be careful of statistics. Start the comparison from other dates in the past and the numbers can look very different.

Property for most is far better understood than the stock market. After all you can see it and touch it. It also appears to be less volatile – but be careful, shares are priced every second, and property only occasionally, so the rises and falls in price are far better disguised. Buy-to-let is a business and you need to approach it as such. It is far more hands-on than an investment and is now beginning to attract more regulatory requirements. For example, 2015 saw the introduction of new requirements on landlords to obtain proof of identity and nationality from their tenants; failure to do so can incur fines of up to £3,000.

Other factors that are extremely important to take note of when weighing up whether to try your hand as a property landlord are the costs of maintenance, agents’ fees and tenancy voids (the gaps that inevitably occur when one tenant leaves and another has yet to arrive). All these will reduce your income return. If you are also gearing up and using a mortgage to buy the property you want to let out, the mortgage payments also need to be taken into consideration. True, the interest payments can be set against tax, but I wonder how long that will last.

In my view buy-to-let is mainly a business to generate income, which is especially valuable today when interest rates are so low. The yield you receive as rental income is very important to making buy-to-let a success. Does a yield of 5% sound enough? That is a figure I often hear talked about on the radio when the subject of buy-to-let comes up, especially in the southeast of England, where capital appreciation has driven prices higher and yields correspondingly lower. It may seem to stack up well against your bank or building society account, but think carefully. My view is that as a buy-to-let investor you should be looking for yields closer to the 7% to 9% mark to make it a sensible business.

It is possible to find properties that you can rent out for that amount, but they are often found in areas far away from where you might live yourself. You are not likely to be buying the house next door. The buy-to-let business, like any other, involves looking for areas with the greatest potential for profit. It requires a huge amount of work to do this properly. Of course, it may be that you will benefit from capital appreciation when you come to sell your property and this will bail you out after a poor income return. This is undoubtedly one of the reasons, along with ultra-cheap mortgages, that so many people have rushed into buy-to-let in the past few years.

But in my view the capital value should be seen as potential icing on the cake, not least because realising it is an all or nothing event.22 The income is what you should concentrate on. There is no certainty that the handsome capital gains of the past 20 years from housing will be repeated in the future. In fact they are highly unlikely to materialise on anything like the same scale. When interest rates start to rise, they will inevitably change the economics of buy-to-let for the worse. With so many young people feeling unhappy about being priced out of housing altogether, the friendly climate for buy-to-let landlords may well change.

The taxation rules that favour buy-to-let are also liable to change23. Property prices could easily fall, as they have done in the past. It would be very unwise to think that in a period of rising interest rates and falling house prices, buy-to-let landlords may not find themselves facing a very uncomfortable financial squeeze. That could be accentuated by the fact that many buy-to-let properties are financed with cheap mortgages. Over the longer term, this leverage does have the potential to magnify potential capital returns, but the flip side is that that can also work the other way round once interest rates start to rise – even if, as I expect, any such rises are gradual and spread over a number of years.

So I say use buy-to-let if you are happy for it to take the time and effort that is inevitable by doing the proper due diligence that you might do on any other kind of investment. Don’t be seduced by headline yields and remember the cost of buying property is very high and this will normally wipe out your first year’s income anyway. Remember too that buy-to-let increases your exposure to property if you already live in a house. Don’t think that property never falls in price. It does. And don’t forget the hassle involved in dealing with tenants, maintenance and all the records you need to keep in order to run a business. Me? I looked at buy-to-let once and decided that equity income gave me far more peace of mind for far less work!

Investing in shares directly

You will have noticed that the book contains very little about buying and selling shares directly. That is because in writing I have relied heavily on my own experience and with the exception of the shares I own in Hargreaves Lansdown, investing directly in equities has never really been a big part of my experience. This is not because I have anything against doing so. I know many people who have been very successful at it. It is mainly because if you are going to do it properly, it requires considerably more time and effort – and also different skills – than I have to offer. I genuinely doubt that most people are willing (or able) to give up that amount of time. But please don’t let me put you off!

With more than 3,000 funds to choose from, not counting offshore funds, I feel that I have more than enough to do to keep on top of my fund research duties. While I enjoy investment, I don’t personally wish to spend all my spare time poring over company reports. I much prefer funds, as they give me instant diversification and a far better spread of investments than I could achieve on my own by buying shares. Another factor is that my job requires me to invest money on a global scale, where stock-picking is even harder to do. I am also lucky to have daily access to fund managers whose ability to pick shares is far greater than mine could ever be. As the old saying goes, if you want a friend for life, go buy a dog. If you want to pick great stocks, go hire a fund manager to do it for you (just make sure they really are that good!).

I have owned shares from time to time, and like most people in the investment business I am quite happy to tell you about some of my greatest triumphs. Back in the year 2000 I did find a ten-bagger (shorthand for a share that makes you ten times your money) in the shape of a company called Cambridge Antibodies. For a while I thought I had found the secret of how to turn lead into gold. I quickly came down with a bump, however, when I lost virtually everything I had invested in another share, a company called Knowledge Management Software. At the time I thought it was on its way to incredible success. It turned out to be a turkey, or a zero-bagger, instead. Honesty compels me to tell you this.

More recently I have done pretty well with a company called Provident Financial, whose capital value has almost doubled in the past couple of years. It also pays a good dividend. Here at least is a business that I can understand. Whether you approve of it or not, money lending has been with us since the age of man and is likely to still be with us in the future. What I like about Provident Financial is that it is a straightforward business with little in the way of technology or biotechnology to understand. It is also a share that I reckon I could easily see myself holding for the long term, which suits my particular style of investing. It isn’t sexy. It isn’t going to make ten times my money in a year. But equally it is not likely to go bust. I very much subscribe to the view that the best way to get rich is slowly.

I also know that many of tomorrow’s stock market stars are already out there somewhere in the AIM and smaller company sectors of the stock market. I am enough of a realist to know that, with my limited time and lack of relevant skills, the chances of my being able to spot them are very small. If you are tempted by investing in shares directly, my advice is to be realistic with yourself about what you can do and the time you can spend on it. Maybe you are an investment genius. Many ordinary investors thought they were just that during the internet bubble, until it all came tumbling down. If you enjoy researching individual shares and have the time and the inclination, by all means press on, but do please go in with your eyes wide open. It helps a lot if you have had relevant experience in business or financial analysis. My advice would be to limit your share dealing initially to no more than 10% of your overall portfolio, in order to find out whether you have the temperament and skills to do the job well. You certainly won’t know how good you are until you have lived through at least one serious market correction and found out how you feel when all your shares have fallen by 25% or more. Only if you survive that will you know for sure that you have got what it takes.

I always note with interest which shares the clients of Hargreaves Lansdown have been buying and selling in the largest quantities. 60% of clients hold at least one AIM stock, meaning they have been tempted by the riskier end of the stock market spectrum. The most popular AIM shares at the time of writing have been Quindell, Sirius Minerals, Monitise, IGas Energy and Falkland Oil and Gas. Dig down further into this list, and it becomes apparent that these types of stock are rarely held for the long term. That suggests that those who buy them are really speculating, or having a punt, rather than what I would call investing. To make things worse, even though the stock market as a whole is up, most of these stocks have lost money. All this buying and selling costs money. None of these stocks fit readily into my criteria of good long-term businesses that pay a good dividend and are likely to be around in many years’ time. It makes me wonder: are the buyers having a bit of fun, or do they seriously expect to make money from their share dealing? And that is why I prefer to stick with my funds – less exciting, certainly, but a safer and more suitable option for my way of thinking.

Points to remember

19 The reason is that it is much easier for an index fund manager to replicate the shares that make up an index of large, well-known companies which are traded in large volumes every day than it is to track indices in smaller, less liquid stock markets.

20 What they can do is issue more shares from time to time, either by buying them in and reissuing them, or making what is called a C share issue. It is still a more cumbersome process.

21 This was the case at the time of writing. The tax arrangements surrounding VCTs will be changing following intervention by the European Union, which may reduce their attractiveness and the way the trusts operate – it is important to take advice or keep up to date with these rule changes before investing.

22 Unless you are dividing a house into flats, you cannot easily manage your capital by selling out in tranches – for example, to manage your tax liabilities – as you can with financial investments.

23 In 2015 the chancellor announced plans to restrict the amount of interest that buy-to-let landlords can claim against tax. The rules on allowable costs are also being changed.