Every investor should have patience, investing is a long game. There are no get rich quick schemes and no easy your way to wealth.
When markets are unpredictable and volatile, like they are at present and in the past. Remaining focused on the basic principles of investing – Is the most important thing an investor can do to achieve success.
As an investor, there are a several factors you can consider helping get through these difficult times including:
Risk & Return
As a Financial Adviser, I will explain to you, each asset class has its own risk (in terms of volatility and risk of loss) and return characteristics. Put simply, the higher the risk of an asset, the higher the return you will likely achieve over the long term and vice versa.
The chart below, displays the relationship or Risk v Return across the major asset classes.
- Cash, as we all know is negligible risk, but also has return potential to match.
- Government bonds usually offer higher returns, although their value can move around in the short term (although major developed countries have not defaulted on their bonds).
- Corporate debt has a higher return potential again, however a higher risk of default.
- Unlisted or directly held commercial property and infrastructure offer a higher return, although they come with higher risk and are less liquid and can be less able to be diversified (except via say a managed fund).
- Equities/Shares can offer another step up in return, although they come with higher risk as they are subject to share market volatility and individual companies can go bankrupt wiping out share holder capital.
- At the top end of the scale, there is private equity which entails more risk and has a tendency to command an even higher return premium.
The key point to remember is that each step up involves more risk, and this is compensated for with more long-term return. Of course, this neat relationship may not hold in the short-term. For example – Government bonds have had worse returns over the last 12 months than shares.
Time In vs Timing in the market
When the markets are volatile it’s always temping to try and time the market. This means to sell ahead of falls and buys in anticipation of gains.
Most investors have had a mixed level of success at doing this. The reason being without a proven asset allocation or stock picking process, trying to time the market is very difficult – almost impossible really.
A comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The chart below depicts, if you were fully invested in Australian shares from January 1995, you would have returned 9.5% pa (including dividends but not allowing for franking credits, tax and fees).
Trying to Time the Market you avoided the 10 worst days (yellow bars), you would have boosted your return to 12.5% pa. If you avoided the 40 worst days, it would have been boosted to 17.5% pa. However, as we all know this is very hard to do, and many investors only get out after the bad returns have occurred, just in time to miss some of the best days and so end up damaging their longer term returns.
For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 7.4% pa. If you miss the 40 best days, it drops to just 3.3% pa. Hence the old cliché that “it’s time in that matters, not timing”.
The key point to remember here is that market timing is great if you can get it right, but without a defined process, the risk of getting it wrong is very high and, it can greatly reduce or even destroy your longer-term returns.
Ensure you have Diversity
The table shown above, shows the best and worst performing asset class in each year over the last 15 years. It can be seen that the best performing asset each year can vary dramatically, and that last year’s top performer is no guide to the year ahead.
It makes sense to have a combination of asset classes in your portfolio. This particularly applies to assets that are lowly correlated, i.e. that don’t just move in lock step with each other. For example, Global and Australian shares tend to move together during extreme events. But bonds and shares tend to diverge when crises hit threatening recession – as we saw in the GFC when shares fell but bonds rallied.
Therefore, there is a case to have bonds in a portfolio to help stabilise returns. Of course, this doesn’t always work. For example – when inflation is the key danger, highlighting the case for cash and real assets like unlisted commercial property and infrastructure too.
The key point to remember is that diversification can provide a level of protection to the volatility. Diversification across a portfolio and exposure to multiple asset sectors means your portfolio will not be as volatile.
Avoid the “Noise” – Look less frquently
For investors who look at the daily movements in the share market, you generally find that they are down almost as much as they are up, with only just over 50% of days seeing positive gains. However, for some unknown reason, most investors seem to only remember the bad days.
The chart below illustrates the level of positivity when looking at share market movement for both Australian shares and US shares since 1900.
As you can see from chart above, looking at the markets every day, it’s pretty much a coin toss 50/50 chance as to whether you will get good news or bad news. Although at monthly basis, the historical experience tells us you will only get bad news around a third of the time.
On a calendar year basis, data back to 1900 indicates the probability of a loss slides to just 20% in Australian shares and 26% for US shares. If you go all the way out to once a decade, since 1900 positive returns have been seen 100% of the time for Australian shares and 82% for US shares.
The key point to remember is most investors invest for the long term and the less frequently you look at your investments, the less you will be disappointed and the less likely you will be affected by market noise. This matters as the more you are disappointed, the greater the risk of selling at the wrong time – which is the worst thing an investor can do.
As Warren Buffet, one of the modern eras most successful investors says: “Invest for the long term and don’t stray – If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
And Remember… Patience is, and always will be, a virtue!
Any further questions on investing successfully, don’t hesitate to get in touch with an Oracle adviser today!
Written by Graham Frater