As 2015 draws to a close, people's thoughts start to turn towards New Year's resolutions, such as going to the gym more often, starting a diet, or learning another language. While these are laudable goals, many investors should also think about changing the way that they manage their money. Here are five small changes to your investment behaviour that could help boost your returns.
Don't trade so often
"Don't just do something, stand there," said former US President Ronald Reagan. Trading less frequently may seem a strange way to boost your returns, but even today, in the age of low-cost online brokers, trading costs can still be significant. This is especially true when you factor in things like the bid/ask spread (the difference between the buying and selling prices). There's plenty of evidence that excess trading leads to worse returns: one study by Brad Barber and Terrance Odean at the University of California found that most US traders underperformed the market by an average of 6.5%. What's more, frequent trading encourages a short-term mentality and can push you away from the shares and asset classes that offer long-term value.
Rebalance your portfolio
Of course, just because trading too much is a fool's game, doesn't mean that you shouldn't trade at all. The evidence also suggests that periodically rebalancing your portfolio is a good idea for two reasons. Firstly, it helps ensure that the portfolio isn't too dominated by one stock or asset, which can happen if it suddenly increases in value. Secondly, rebalancing your portfolio helps you sell overvalued assets and replace them with those that are undervalued. One study showed that if you'd split your portfolio 60/40 between stocks and bonds in 1985, annual rebalancing would have beaten the market by 9% over the next 25 years, compared to if you had simply let it run.
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Focus on value
Research suggests "value" shares those that appear cheap on measures such as price/earnings (p/e) and price/book (p/b) on average outperform those "growth" stocks with higher multiples. If you had put $10,000 into large-cap growth shares in the US in 1980, they would have been worth $187,071 by 2010 (excluding fees and taxes), according to data from fund manager Fidelity. The same amount in large-cap value stocks would be worth $305,169.
Of course, value investing isn't the only investment strategy that works. However, it is one that is well suited to retail investors, because it involves buying undervalued shares and holding them until them become overvalued. Other strategies, such as focusing on shares with strong price momentum, have also worked but require more frequent trading. That means higher costs.
Remember dividends
It's easy to think of profits solely in terms of capital gains (the amount that a stock's price goes up or down by), but it is dividends that determine long-term returns. If you'd invested £100 in the UK stockmarket at the end of 1945, it would've been worth £9,148 by the end of 2014 if you ignore the impact of dividends, according to data from Barclays. However, if you reinvested all the dividends you received back into the market, your original £100 would be worth £179,695. Of course, just because a stock has a high yield doesn't always make it a good investment. It's important to consider how safe the dividend is, especially given that many investors are relying on a shrinking pool of income stocks (see below).
Choose low-cost funds
One of the big developments over the past decade has been the rise of cheap index funds and exchange-traded funds (ETFs). These track a benchmark such as the FTSE 100, rather than trying to beat it. This means they can be cheaper because they follow set rules, they don't need to employ teams of research analysts or fund managers. Competition in this sector has pushed prices down to the point where the iShares FTSE 100 UCITS ETF (LSE: CUKX) has total fees of only 0.07%. Studies show that the average active manager underperforms the market. So investing in a tracker is likely to deliver stronger returns at lower costs.
How safe are UK dividends?
It's been yet another bad year for the FTSE 100. Trading at under 6,100 at the time MoneyWeek went to press, the index is barely above the level it was at three years ago. However, steady dividends have helped investors eke out a modest profit: including reinvested dividends, the market has returned 15% over the last three years (4.8% per year). But will this continue? While the UK market's dividend yield looks attractive (4.3% for the FTSE 100 and 3.6% for the FTSE All-Share), that is dependent on an ever-smaller pool of companies, according to analysts at Societe Generale. Just 24% of stocks yield morethan the market the lowest figure since their data series beganin 1989.
This means that income investors are increasinglyexposed to the risk that dividend cuts by a handful of firmscould have a surprisingly big impact on what they get paid.That's especially worrying given that many of today's highest yieldingstocks are in the energy and mining sectors, wheredividends are under threat due to the slump in commodityprices. If you're building an income portfolio, focus on safe andsustainable yields, and make sure you're diversified amongplenty of individual companies.
