14 steps to successful investing
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Shane Oliver is head of investment strategy with AMP Capital.
The last five years have been difficult for investors. The global financial crisis (GFC) and its aftermath of private-sector deleveraging, public-sector debt problems and household, business and investor caution have led to poor and volatile returns from shares. It seems we are constantly on edge with prognostications of doom getting constant replay with every twitch in markets.
Just like The Rolling Stones' single last year says, "All I hear is doom and gloom". Methods of investing that seemed to work well for years have seemingly broken down, or at least many have lost faith in them.
So, what should investors do? The following is a list of things that are critical for investors to know and do. Obviously, when it comes to investing, everything is debatable to some degree, but I hope you find this list to be of value. First, some investment market realities.
There are four key things to bear in mind about investment markets.
1. There is always a cycle
The historical experience of investment markets - be it bonds, shares, property, infrastructure, et cetera - constantly reminds us they go through cyclical phases of good times and bad. Some are short term, such as those that relate to the three to five-year business cycle. Some are longer, such as the secular swings seen over 10 to 20-year periods in shares. But all eventually contain the seeds of their own reversal.
Ultimately, there is no such thing as new eras, new paradigms and new normals. Such jingles - as wheeled out through the tech boom and more recently through the post-GFC gloom - make good marketing spin. But markets tell us there is nothing new under the sun. In fact, when someone tells you about a new "whatever," it has probably already run its course.
2. It's a mad, mad, mad world
It's well-known that investment markets are prone to bouts of irrationality, which take them well away from levels that may be justified on a long-term basis. This is rooted in investor psychology, which is far from rational and flows from a range of behavioural biases investors suffer from.
These include the tendency to overreact to the current state of the world, the tendency to look for evidence that confirms your views, overconfidence (particularly among males!), an erroneous feeling of safety in numbers, and a lower tolerance for losses than gains.
While shifts in fundamentals may be at the core of cyclical swings in markets, they are usually magnified by investor psychology if enough people suffer from the same irrational biases at the same time. This in turn creates opportunities for investors who can take a longer-term approach and look through extremes of market madness either on the upside or the downside.
3. Starting point valuations matter - a lot
It stands to reason that the cheaper you buy an asset, the higher its prospective return will be and vice versa. Good guides to this are price-to-earnings ratios (the lower the better) and yields, that is, the ratio of dividends, rents or interest payments to the value of the asset (the higher the better).
But while this seems obvious, the reality is that many find it easier to buy after shares have had a strong run because confidence is high, and sell when they have had a strong fall because confidence is low.
4. The power of compound interest
Although the average annual return on Australian shares (11.9 per cent per annum) is just double that on Australian bonds (6 per cent per annum) over the last 113 years, $1 invested in bonds in 1900 would today be worth $704, whereas $1 invested in shares would now be worth $350,356.
Yes, there were lots of rough periods along the way for shares just like the last few years (for example, the 1930s, 1970s, 1987-96), but the impact of compounding at a higher long-term return is huge over long periods of time.