What are stocks?
Stocks simply represent ownership in businesses. When you buy 100 Roche shares, you become the legal shareholder of part of Roche. This entitles you to certain rights, for example attending shareholder meetings and voting in key strategic decisions relating to the company.
There are economic benefits to being a shareholder as well: you can receive part of the profit the company makes every year (in the form of a dividend), should the board of the company decide to make a payout. You may also sell your shares at a profit (or loss) to other willing buyers in the open market (making a capital gain or loss).
Lastly, as shareholders participate directly in the economic benefit of a company, they also bear the most risk when it comes to the liquidation of the firm (for example in the event of bankruptcy). It means that any proceeds from the sale of the company will be used to pay off other creditors first before reaching shareholders (if any).
Investing in the best Swiss stocks
With the hundreds of companies listed in exchanges in Zurich and Bern, it can be daunting to decide which stock to include in your portfolio. After all, it’s important to make money, but it’s far more crucial not to lose any! Here we have composed an easy-to-follow guide on how to invest in the best Swiss stocks.
1. Decide how much to invest
There are many theories about the amount of capital you should commit to the stock market. If you ask 10 different professionals, you are likely to get 12 different answers.
Most investment managers would advise their clients by asking them to commit capital they won’t need for the next 5 years or are happy to lose. We think this is suboptimal for 2 reasons:
1. Five-years is way too short a time horizon to be investing in stocks. We are in the midst of a decade-long bull market and the end is still not in sight.
2. Encouraging investors to think about “happily losing money” is not only wrong but also reckless. It is effectively framing investment as quasi-gambling scheme and legitimising the flawed concept that losing money is part of life. In reality, with proper risk control and due diligence, investors with spare cash should expect much more than the unexpected.
Instead, it is better to start by considering the amount of capital that may not be needed in the next 10 years. A decade is a really long time and if you won’t need the funds during that time, chances are you can plan for the long-term.
Then calculate that amount as a percentage of your net worth and think instinctively about whether you are comfortable committing that portion of your wealth in the stock market. This exercise puts the nominal value of the capital into perspective. If you feel uneasy, then reduce the percentage to a level that you are comfortable with.
2. Open a brokerage account
It may sound obvious but your best investment ideas won’t take off unless someone is willing to facilitate and execute the trade. For that, you need a stock brokerage account.
Thankfully as a commodity service, brokerage services are both plentiful and competitively priced. Chances are, your local bank will offer such a product and a simple online application alongside your proof of identity and address are usually sufficient to open one. Alternatively, there are dedicated stock brokerage service providers (e.g. Interactive Brokers) that provide no-frill low-cost self-services. They can be an affordable and effective solution for many investors.
Given that you’ll be holding a significant amount of cash in the account at one point or another, it is prudent to ensure that your account is insured with the Swiss deposit insurance scheme in the unlikely event of your broker going out of business.
If you live outside of Switzerland, simply check with your local broker to see if they offer trades in Swiss stocks as most reputable brokers in the EU and the OECD countries do.
3. To manage or to be managed?
There will come a point that every investor will need to confront: do I manage the portfolio myself or shall I outsource to a professional?
There are 3 key ways to manage an investment portfolio and we will explore the pros and cons of each.
DIY (or execution-only)
Overview: You are responsible for all the trading and administrative management of your portfolio. Your broker simply executed your trading instructions.
Ultimate trading authority: You
Costs: Transaction costs + research cost + your time. Usually should not exceed 0.5% of your total assets per year.
Minimum threshold: CHF 1,000
Knowledge about investment: Medium
Time/effort commitment: High
Overview: Your broker (or investment manager) has a full mandate to invest your assets at their discretion, subject to the agreed parameters.
Ultimate trading authority: Investment manager
Costs: At least 1% of your total net asset value per year plus transaction costs
Minimum threshold: CHF 50,000
Knowledge about investment: Low
Time/effort commitment: Low
Overview: Your investment manager provides research and advice on areas that are of interest to you. You retain the ultimate trading decision-making and authority.
Ultimate trading authority: You
Costs: Advice is calculated on a time-spent basis, ranging from CHF 150 to 400 per hour. Transaction and portfolio costs are added on top of that.
Minimum threshold: None but uneconomical if the portfolio is less than approx. CHF 100,000
Knowledge about investment: High
Time/effort commitment: Medium
As you can see, both DIY and the Advisory approach require investors to have a certain level of knowledge about investing and the market. As a result, if you are a complete novice, hiring a professional to manage the portfolio is probably the most appropriate solution.
There are several areas that you should pay attention to when outsourcing to an investment manager:
- Most investment managers underperform market benchmarks. Even veteran stars can fail that hurdle, sometimes abysmally.
- Investment fees can have a tremendous drag on performance when compounded over time.
- Investment managers’ key incentive is to generate fees for themselves. Providing good service and performance is likely to be a byproduct for many of them.
As a result, we highly recommend all investors to educate themselves as quickly as possible and turn to manage their portfolios themselves.
4. DIY: passive vs active
Assuming you’ve decided to forgo the hefty fees and manage the portfolio yourself, you will soon face the question of whether to run it passively or actively.
Passive investing is also known as index investing. It means that instead of attempting to beat market benchmarks (also known as indices), an investor simply tried to replicate its performance and achieve the same level of gains and losses as the indices. Passive investing makes extensive use of index-tracking mutual funds and ETFs.
Active investing, on the other hand, refers to the practice of trying to achieve returns that is over and above market benchmarks (also known as alphas). This strategy usually involves screening, analysing and picking individual stocks to create a diverse but concentrated portfolio which in turn attempts to beat the specific index being tracked.
Comparing active and passive investing:
Entry threshold: Starting from CHF 1,000
Transaction costs: Very low, CHF 50 can diversify the portfolio into hundreds of underlying stocks.
Management costs: Low, the Total Expense Ratio (TER) of index funds rarely exceed 0.5% per year.
Investment knowledge: Low to medium
Number of holdings: Hundreds
Ability to tailor to investment objectives: Low
Entry threshold: Starting from CHF 50,000
Transaction costs: Slightly higher as each stock needs to be purchased and sold individually, incurring trading charges.
Management costs: Low to non-existent. Holding individual stocks usually does not incur any costs.
Investment knowledge: Very high
Number of holdings: Usually less than 25
Ability to tailor to investment objectives: High
It is quite evident that unless you possess deep investment knowledge, have superb financial management skills as well as access to a large amount of capital, most investors would be best served by pursuing the passive route.
5. Passive investing and the common pitfalls
It is very easy to think that once you’ve bought several index funds and ETFs, all is well and you can just sit back and relax. The truth is much more nuanced. There are several common pitfalls that every passive investor should avoid at all costs:
- Replication error - it sounds obvious but if your chosen fund cannot accurately replicate the index it is tracking then it is not very useful. Make sure you check the deviation of the fund from the index it is tracking. Anything over 1.5% is unacceptable. You can avoid this by picking a reputable fund provider (e.g. BlackRock).
- Spiralling costs - believe it or not, some index funds or ETFs carry pretty hefty costs, like this one. The 0.8% TER is 10 times that of a generic S&P500 index fund and the effect of fees will compound over the years, dragging the performance. As a result, make sure you really understand the objective the fund serves in the portfolio before purchasing and whenever in doubt, just buy a cheap generic all-share index fund/ETF.
- Forget to rebalance - every portfolio will deviate from the target objective as time passes and it is important to rebalance to ensure it remains on track. Whilst this can be an entire article to itself, the easiest way is to analyse and determine if the asset allocation based on the current value is still in line with the target. If not, then change it to the desired allocations. Rebalancing should be performed annually on a passive portfolio.