Four funds to set you up for life
Thursday 08 Apr 2021 Author: Yoosof Farah

The new tax year is now underway, which means you’re able to fill up your ISA again with another £20,000.

For those just starting out who want to put their money to work in the markets but aren’t yet confident enough to pick their own stocks, we have come up with a portfolio of exchange-traded funds (ETFs) which offer a simple, no-stress option which could set you up for the long term.

ETFs are an excellent option for a beginner investor. An ETF is a type of investment that simply tracks an index, like the FTSE 100 for example, and so mimics its returns. That means they are low cost compared to an actively managed fund, where a fund manager picks out the stocks or bonds they think will outperform the rest of the market.

FUND MANAGERS DON’T ALWAYS OUTPERFORM

However fund managers don’t always outperform, and their higher fees can eat into your returns, something which is less of an issue with ETFs.

Once you are further along in the world of investing and have a better understanding of how the markets work, and are able to compare the track records of different fund managers, then actively-managed funds could well become a good option for your portfolio.

ETFs also give you that all important diversification, so if one or a few investments in the ETF perform badly, there will typically be many others which perform better to offset the losses.

More often than not ETFs give you better diversification that actively managed funds, which tend to have fewer holdings in their portfolios.

That’s also why it’s best to avoid investing in individual stocks until you understand the ins and outs of the stock market, because putting all your money in one or a few stocks leaves you a lot more exposed to the whims of the stock market and investor sentiment and gives your money none of the protection provided by having a diversified portfolio via ETFs or funds.

So as you embark on your investment journey, here is the simplest starter portfolio ever for your ISA. Four ETFs is all you need.

PORTFOLIO FOR YOUNGER INVESTORS

For someone who’s in their 20s, 30s or 40s and has time on their side to invest for the long-term, it is worth opting for ETFs that give you access to all the important stock markets in the world that offer the best growth potential.

We’ve chosen to ignore bond ETFs and dividend-paying ETFs as someone who has more time on their side can afford to take more risks and keep their money invested for longer in order to smooth out the ups and downs stock markets always go through. Stocks also typically provide better returns over the long term compared to bonds, albeit with more volatility.

ISHARES CORE MSCI WORLD (SWDA)

What better way to get started with investing than to buy an ETF that puts your money to work in stocks all over the world?

The MSCI World index is the most commonly used index to track companies in all the developed markets across the world and with well over 1,000 stocks in there it’s certainly diversified.

More than anything it’s a play on the US, which makes up 66% of the index and has all the big US tech stocks in its top 10 holdings – together they alone make up 10% of the index – so you’ll feel the benefit if the likes of Apple, Amazon, Facebook, Microsoft, Tesla and Google owner Alphabet continue to perform strongly in future.

Its present bias towards growth companies means it may not shine in the short-term when value stocks are in favour.

This is reflected in a return of just 1.6% so far year-to-date as the value rally continues. However, over the longer term it should deliver strong performance and indeed has a five-year annualised return of 14.73%.

There is also the benefit of not having all your eggs in one basket as the index also includes stocks from the UK, Japan and other countries like France, Germany and Canada.

The best ETF to pick to follow the index would be iShares Core MSCI WORLD (SWDA), which is one of the cheapest options with an annual fee of just 0.2% of your invested cash, and also has the lowest cost between buying and selling due to its highly liquid nature – the ETF holds $34.3 billion of investors’ money.

The specific ‘SWDA’ version has been picked because this is the GBP share class. It’s important to always pick the GBP version to avoid any unnecessary foreign exchange charges for converting US dollars into pounds for example. For all ETFs mentioned in this article we’ve picked out the GBP share class.

ISHARES MSCI WORLD SMALL CAP (WLDS)

Global small cap stocks have outperformed their mid- and large-cap counterparts on average over the last decade, and could be a good option to potentially add some decent growth to your portfolio.

There is always the risk they will do worse than their larger peers when stock markets go through turbulent periods where performance is volatile but over a market cycle of at least five years their better growth potential than large and mid-caps could be realised.

The best option here would be iShares MSCI World Small Cap (WLDS), which follows the MSCI World Small Cap index and is one of the cheapest options to track global smaller companies with a 0.35% annual fee.

Again the index has heavy exposure to the US which makes up 60% of the index, and the stocks in it aren’t exactly small by UK standards with the average market value of each constituent in the index standing at just over $1 billion.

But they are certainly small compared to giants like Amazon and Tesla, and many have been in favour so far in 2021 as global investors look outside the big names to find growth.

VANGUARD FTSE EMERGING MARKETS (VFEM)

Given they’re based on some of the fastest growing economies on earth, having exposure to companies in your portfolio from emerging market countries is a good idea.

There are risks with these markets, considering they are still emerging and can frequently encounter teething problems as they develop, but someone willing to ride out volatility over the long term could potentially see some very decent growth from their investment.

ETFs are among the best ways for a beginner investor to access emerging markets, as they give you the diversification of emerging markets across the world and not just a specific region like many actively-managed emerging market funds.

One of the best ETFs to pick for emerging markets exposure is Vanguard FTSE Emerging Markets (VFEM), a popular ETF which is one of the cheapest ways to access these high growth markets with a low ongoing cost of 0.22% a year.

Most ETFs track the MSCI Emerging Markets Investable Markets index, but the Vanguard one tracks the FTSE Emerging Markets index.

Both indices have a lot of their exposure to China, but the FTSE one has a greater allocation to Chinese stocks at 44.5% of the index compared to 36.6% for the MSCI one, and also has a higher weighting towards technology stocks.

This in part reflects the fact that, unlike MSCI, FTSE considers South Korea to be a developed rather than an emerging market.

AMUNDI MSCI WORLD SRI

In the investment world, investing ethically is becoming less and less of a niche thing propagated by unheralded trailblazing fund managers, and more and more a de facto part of the general investment process.

However, picking an ethical ETF that puts money to work in the way you want it to and conforms to the spirit of the environmental, social and governance (ESG) criteria created by the investment industry can be something of a minefield.

No option we pick here is perfect, but one good option could be Amundi MSCI World SRI (WSRI), which focuses on something called SRI, meaning socially responsible investing, and has an annual charge of just 0.18%.

The ETF follows the MSCI World SRI index, which screens out stocks involved in thermal coal, nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, genetically modified organisms and adult entertainment. Ethical criteria are then applied to the remaining stocks and the top 25% left over are then picked to go into the index.


PORTFOLIO FOR SOMEONE CLOSER TO RETIREMENT

For someone in their mid-50s onwards who’s looking to get started in investing and put their ISA money to work, but perhaps doesn’t quite have the same amount of time to ride out all of the volatility in stock markets over a few market cycles, we suggest still buying both the iShares Core MSCI World ETF and the iShares MSCI World Small Cap ETF, but adding a bond ETF to offer portfolio protection against volatility and a dividend-paying ETF to offer some income.

VANGUARD CORPORATE BOND (VUCP)

A lot of investors when thinking about investing in bonds might immediately turn to gilts, i.e. UK government bonds. While they have often been seen as something of a safe haven investment, gilts don’t exactly offer a great return on your investment.

One way to get some of the safety that bonds provide, but still actually see some decent returns on your investment could be through investing in corporate bonds, which are bonds issued by companies.

One of the most popular options for investors looking to access corporate bonds has been Vanguard USD Corporate Bond (VUCP), which has a charge of just 0.09% a year and offers access to over 5,500 investment grade company bonds.

These include bonds from the likes of AT&T, Verizon, Comcast, Citigroup and Budweiser maker Anheuser-Busch InBev – all companies which the top credit rating agencies think are unlikely to default on their borrowings.

ISHARES UK DIVIDEND (IUKD)

The UK stock market has the highest dividend yield by country according to data from Siblis Research with an average dividend yield of 4.66% from the FTSE All-Share, and with dividends back on the menu again from FTSE 100 and FTSE 250 companies adding some home market exposure marks sense.

The most popular ETF in this regard has been iShares UK Dividend (IUKD), which currently offers a 4% yield with dividends paid quarterly. It does have a relatively pricey ongoing charge for an ETF with an annual fee of 0.4% a year, but contains a lot of strong, reliable dividend-payers including utilities National Grid (NG.) and SSE (SSE), and miners such as BHP (BHP) and Rio Tinto (RIO), which are currently paying out hefty dividends with yields of more than 6% on the back of booming commodity prices.

UK stocks have also been considered cheap by global standards and with value stocks set for a good 2021, the ETF also has the potential to offer capital growth as well, particularly given the combined price-to-earnings ratio of its holdings stands at a lowly 10.6 times.

 

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