I remember a good friend once telling me a joke, “How do you get an IFA to make you £2M……..you give him £4M”.

I laughed out loud but, to be honest, everyone makes mistakes, even the experts.

Over the years we’ve had our share of nightmares here on the Island, we don’t really need to go into them here. But notwithstanding these bad experiences, how do we go about spotting a good investment, from say an average one (or indeed a bad one)?

Well, I’ve got some tips on how to approach this:

1. Buy Low – Sell High
Seriously, I know you’re all rolling your eyes, but here’s the deal; if you buy something when it’s expensive (because it’s a good fund or stock), then all you’re doing is hoping that others coming later to the party will buy into it as well and thus push up the price.

This is called the Greater Fool theory – and the term sort of explains itself…

2. Understand your investment
If you’re going to invest your own hard-earned cash yourself (as opposed to seeking professional advice) then do some research and understand how it works – how it REALLY works.

There are lots of investment formulas out there that tell you all sorts of things about your potential investment, but there are some which are important to know (such as P/E ratio, Alpha, Sharpe, IR, Standard Deviation, EPS and Beta).

And don’t be put off by the fancy names, once you get to grips with these, then it becomes easier to understand what the data is trying to tell you.

3. Get a grip of risk
Is investing in blue chip shares on the FTSE 100 risky?

Some people would say it’s low-risk investment (and not just Hedge Fund Managers) whilst others believe ANY sort of equity invites volatility and therefore increased risk.

What you’ve got to do is properly understand how much you can afford to lose and start from that position.

If the stock market fell by 10%, would you hit the panic button or see it as an opportunity to invest?

4. Avoid complexity and opaqueness
This somewhat ties in with point 2.

If something seems so complex that you don’t understand a word of what your adviser tells you or the only thing you’ve read is a key features document, then stay clear.

Investments should never be that complex nor should their structures be either (ok, Hedge Funds excepted).

Bottom Line: stay clear of complex and elaborate structures.

5. Be clear on charges
Next to poor asset allocation this is the number one reason that returns can be diminished.

Every little fish in the sea wants a nibble at your investment returns – so get on top of this at the start.
And watch out for funds with ‘investment barriers’ where the manager gets a ‘bonus’ if he or she hits a certain return. It’s nonsense – and avoid it (unless it’s a Hedge Fund, but if you’re reading this blog, then you’re unlikely to be a Hedge Fund investor).

6. Passives/Actives or a Mix
I a whole load about this in a couple of my earlier blogs, so give them a read if you need an update.

Basically though, you need to understand the differences and the pros/cons for each one.

A lot of it comes down to whether you believe it’s possible for managers to beat the market or not, let alone make better calls than the market – it’s called “efficient market hypothesis” and it’s worth understanding the difference.

6. Diversify your Portfolio
It’s almost a cliché, but that doesn’t make it untrue.

I won’t labour the point, but did you know that a portfolio of 20 to 30 stocks is required before it begins to take lower non-systematic risk i.e. the risk associated with individual stocks going belly-up?

7. Understand your limitations.
This may be the most important point because it requires a level of critical self-analysis. Many of us are guilty of having biases associated with certain behavioural finance, such as investors:

• giving too much weight to recent experience compared to prior beliefs when forecasting
• overestimating the precision of forecasts
• being too slow in updating their beliefs with new evidence
• inferring wider population behaviour from small sample data

Behavioural finance biases such as cognitive dissonance (ignoring evidence that things might be going wrong), group think, herd-like behaviour, over confidence and regret avoidance (fear of missing out), are all examples of investor behaviour that we need to avoid (but don’t).

Next time I’ll talk about how to get a good income from an investment portfolio.