The golden rules of investing
Superannuation | 14/02/2018 |
8 min read
At first glance, investing can seem daunting. So much complex information and so little time to absorb and act on it when you’re busy getting on with life. It’s little wonder that so many of us put it in the too hard basket for longer than is good for our wealth.
The good news is that investing doesn’t need to be hard. The basic rules of investing are surprisingly simple and timeless.
Set your objectives
“Before beginning a hunt, it is wise to ask someone what you are looking for before you begin looking for it.”
Winnie the Pooh was on the money with this observation. If you want to reach your personal and financial objectives you need to define what they are.
Ask yourself where you want to be in 5, 10 or 20 years’ time. Be specific. Put some dollar figures beside each goal and then start planning how you will get there. A good financial planner can help you chart a course for long term financial goals. But even something as simple as an annual savings goal can help you organise your money.
The genius of compounding
Albert Einstein said compound interest was man’s most powerful discovery, but it doesn’t take a genius to put it into practice. Compound interest simply means interest on your interest. Over time, this simple concept becomes a powerful wealth creation tool.
Say you invest $10,000 today at 5 per cent. With compound interest it will grow to $27,126 in 20 years. If you were to spend those interest payments rather than reinvesting them you'd end up with $20,000 in 20 years.
That’s the genius of Australia’s superannuation system - it locks away your savings and all investment earnings until you retire. Even if you’re on a modest salary, time allows compound interest to weave its magic.
Take your time
We all know we should take an active interest in our super and other investments, but can you be too proactive? Yes, according to a study by US fund manager, Fidelity Investments. A review of clients over a decade found the best performing accounts were for investors who were dead! Next best were investors who had forgotten they had accounts. The thing both groups had in common was that they were not actively trying to time the market.
A landmark study of 66,000 investors by the University of California reached a similar conclusion. The most active investors underperformed the overall sharemarket return by 6.5 per cent a year, leading the researchers to conclude trading is hazardous to your wealth.
The lesson is not to do nothing. Instead, be patient and stick to your plan.
Reduce risk with diversification
‘Don’t put all your eggs in one basket’ is an oldie but a goodie. Shares, property, bonds and cash all have good years and bad. Even though shares and property provide the best growth in the long-term, prices can fall or move sideways for years at a time and you don’t want to be forced to sell in a downturn because you need the cash.
The way to reduce the risk of crystallising losses or losing everything on one dud investment is to diversify across and within asset classes. The right mix will depend on the timing of your goals and your risk tolerance. Think about investments that provide capital growth in the long run and income when you need it – from bank deposits, bonds, share dividends or rental income from investment property. And don’t forget to build a cash buffer for emergencies.
Follow the cycle, not the herd
Markets tend to rise above true value when investors join the stampede to get in quick for fear of missing out. Prices also tend to fall too far when a wave of panic selling grips the market and everyone tries to sell at once.
Long term asset class returns. Via AMP.
Following the herd is a risky strategy, but you can profit from keeping an eye on the herd’s behaviour; buying when investors are fearful and selling when they’re greedy. When you take a long-term perspective, and have clear investment goals, it’s easier to sit back and watch market cycles unfold. Then when you see an opportunity to buy quality assets at a low price, or sell an investment that no longer meets your objectives at a high one, you can pounce.
As the chart above shows, investors who panicked during the 2007-08 financial crisis and switched out of shares into cash and bonds would have done better to sit tight and ride out the volatility. And investors who took the opportunity to top up their holdings when the market was gripped by pessimism would have done even better.
Speak to an Equip financial planner about your long term goals and how to achieve them. Click here for more details.
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