Many funds struggle to outperform their peers or the market they invest in, leading some people to wonder why they are paying an active management fee at all.
One option for disgruntled investors is to pick stocks themselves, either to supplement holdings in funds or as a replacement.
Keith Bowman (pictured), equity analyst at Hargreaves Lansdown, says that many investors get into stocks as a natural progression from funds.
"A lot of people may go from funds into individual companies via an industry they know or work in, which I think is often a first step for many investors," he said. Bowman adds that this can be a good route in, but says investors need to be careful that they diversify their holdings away from these industries if they make up any significant part of their portfolio.
The next step often tends to be consumer-facing businesses that investors are familiar with, but again, the problem is concentration risk.
"One of the things that often happens is investors tend to be influenced by stocks they can feel and touch, so a well-held sector is the retail sector itself, and the high street banks, because when people go about their daily business they are in and out of the banks and these retailers."
"I’m not saying they shouldn’t be investing in these companies, but investors should be aware there are other options."
Investing in small caps is a popular strategy for many do-it-yourself investors, as Bestinvest’s Jason Hollands (pictured) explains. "You find a lot of investors who pick shares tend to be interested in smaller companies where there’s the opportunity to do your homework and find a story that the rest of the market hasn’t picked up on," he said.
Bowman warns this can lead investors down the wrong route, however.
"They are certainly less researched than their larger cousins, and that’s something to consider, but having said that, people often get sucked into looking at smaller companies to look for the short-term and mid-term share price rises rather than looking at the broader picture," he said.
Hollands says that there are two main types of stock investor: those who dedicate a certain part of their portfolio to trading in equities, usually small caps, and those who pick two or three large cap companies they are happy to hold for the long-term.
He adds that discount brokers have cut the cost of investing directly for both types, but that each class of investor should look for a different charging structure.
Some brokers have lower charges per transaction, which suits those who trade more frequently, meaning that investors need to shop around to find one that’s right for them.
Everyone needs to bear in mind that they will have to pay their broker to hold their shares in the online account, although the charges are likely to be low.
Why you should be wary
Hollands warns investors against devoting too much of their portfolio to directly held stocks.
"There’s a whole range of information available for free on the internet which there wasn’t a few years ago," he said. "However, you should only do it if you are prepared to do the homework."
"You are taking on much more risk in putting your money in a single stock rather than in a concentrated portfolio of 80 to 100 holdings."
Bowman agrees that investing in shares as part of a diversified portfolio is the more sensible option.
"I would make a point of keeping your investment to a manageable level and not letting it get too big compared to your portfolio," he said.
In terms of how to go about picking stocks, Bowman says there is no one right answer.
"I think it’s a tough one; there will be different criteria that will suit different investors," he commented.
"One approach is that you might look for general trends that are driving the economy or a certain industry."
"For example, the housing market recovery in the US: what companies will benefit from that? Wolseley on the FTSE 100 and Ashtead further down are two."
Data from FE Analytics shows that building materials firm Wolseley has seen impressive share price gains of 67.71 per cent over the past year, while equipment rental firm Ashtead has grown by a massive 205.66 per cent.
Performance of stocks over 1yr
Source: FE Analytics
Another thing to look for is the company management, Bowman explains.
"A bit like football managers, sometimes the CEO has a good track record and that can be something to consider."
Valuations are the tool most often used by professional managers, and Bowman says they can also be useful for the retail investor.
"There’s no harm in looking at some of the valuation yardsticks. In terms of which to use, it’s difficult – do you use historic or future valuations?"
"If future, you have to remember they are based on analysts’ forecasts and those can be wrong," he said.
"If those analysts get their forecasts wrong, then the figures are wrong. I’m not saying don’t use them, but take them into account."
The analyst suggests that investors consider the yield on the stock as a crucial part of its total return.
"Sometimes people go for smaller companies where there isn’t a yield but it’s where most of your total return comes from in the stock markets."
Hollands says that investors need to ensure they do not put too much of their savings into these riskier strategies.
"A lot of it comes down to your own appetite and interest. Most of our clients are not experts or hobbyists and prefer to contract their decisions to fund managers."
"If you really think you are a better fund manager than the professional, then have a go, but you have to have a high degree of confidence in your ability."
"Do you really have the time? Even more so with smaller companies, where you really have to see the whites of the eyes of management. Most private investors are probably not in a position to do that."
"However, I wouldn’t deter anyone who wants to do it as a hobby," he added.
