The 4 Things Every Investor Should Know

We live in challenging times.  It has been a long time since rising markets have been so generous as to forgive the sins of a poorly constructed investment portfolio.  And it is in uncertain times such as this that it is worth remembering what we can rely on.  
With this in mind, we thought it timely to list the definitive top four investment principles that every investor should know:

1. How you allocate your investment capital across the different asset classes is by far the biggest determinant of portfolio performance.  Academic research shows that more than 90% of the long-term performance of an investment fund, is determined by its asset allocation.   Market-timing and individual stock selection are shown to have been unable to produce enough value to overcome the associated operating expenses and transaction costs of active management. Stock-pickers take note!
2. Stop thinking that you can second guess the market.  All the news, good and bad, is already reflected in the market price. Also, the probability of you being consistently smarter than the collective knowledge of all other market participants …. well, let’s just say that it is improbable.  Empirical research has found that even professional fund managers who do this for their day job have real trouble beating the market consistently.  And most don’t.
3. The best protection against volatility is diversification, both across the asset classes and within each asset class. Yes we have all heard this before – that is because it is an investment truism, so don’t break this golden rule.
4. Heads and tails … risk and return, two sides of the same coin.  When risk is high, investors gravitate toward safe assets and away from riskier assets.  The prices of riskier assets adjust downwards thereby offering a higher expected return for those assets.  This reminds us of a great quote from Warren Buffett  “Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance”.

Sorry if we are sounding like a broken record here but these are the fundamentals of a good investment strategy ..... applying them provides the highest probability of a successful investment experience.

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Image: FreeDigitalPhotos.net

One of life's lessons ...

Our 100% growth investors have had a bumpy ride, like most over the last few years, but it's very interesting to note how quickly the recovery can happen - you can't afford to miss it.

To 2nd April 2012, our 100% growth investors - diversified across domestic, developed international hedged markets and emerging markets experienced a - 6.17 % return for the 12 months.  But when you look at what has happened in just the last 92 days - they've had an 11.09% recovery.

To look at a longer period, if you invested $1,000 in the ASX 300 in June 1992 through to December 2011 - you would have achieved 8.8%pa average return - $5,232.  Not a bad average given that we've had the Gulf War, 911, the Afghan War and a GFC during that period.  However if you missed only the best 15 days in that 19 year period, because you retreated to cash when the world looked uncertain and markets got volatile, or perhaps you got concerned about what the European Debt crisis would mean for stock prices, then your average annual return would have dropped to 5.1%pa or only $2,641.

Unfortunately fear drives many investors to miss the returns that are available to them.  They're convinced that they know something that the market doesn't.  It's just not true - the market is efficient at taking all new information and factoring it into prices very quickly.  We are more globalised than ever and whilst pricing mistakes can happen, it's not as often as you think.

It doesn't help investors that most economists don't get it right either.  In the SMH/Age Economists survey on Jan 6 2008, 28 leading economists forecast that the $AUD would go up to $0.90 US cents (from 88c), the cash rate would go up to 7.5% (from 6.75%) and that the ASX 200 would go up 8% to 6800.  What actually happened was that the AUD dropped to 70 US cents, the cash rate dropped to 4.35% and the ASX 200 was down 41% to 3722.

Then in Dec 2010, the same SMH/Age Survey (21 economists) forecast the AUD down 10% - it went up 5%, forecast the cash rate to go up to 5.25% from 4.75% and it went down to 4.25% and that the ASX 200 would go up 8% to 5169 and it went down by 14.5% to 4056.

The video clip below, The Investment Answer, provides some useful insight.

The lesson is to realise that market timing will cost you more than it will save you.  Successful investing does not require a crystal ball - it requires discipline.

When the markets let us down.

Just listening to the recent news of world markets, got us thinking. 

We can’t control what happens in the markets – we can have an opinion, we can listen to others opinions but there’s nothing we can do, to affect the outcome.  So when the news is so depressing, what can we do?

In times like this, when our investments are heading south, we have to focus on “what we do” and “why we do it”, more than “what we have”.  What I really mean, is that we need to be more grateful.  Australians are very fortunate.  We have an exceptional lifestyle of choice, fine weather, supportive health system and although it’s not perfect, a better economic environment than most others.

In the last few weeks, we’ve had some sad news from a few of our clients suffering from life changing illnesses.  It’s a reminder of how precious life is and how we have to enjoy every day and spend quality time with our loved ones.  If we wait for the markets to improve, or we wait until we “have enough money” to fully enjoy life, then we may miss out.

Somehow, we all need to find happiness and joy in the every day life we live.  As Trusted Advisors we take our role in this very seriously.  How do we provide peace of mind, encouragement and support to clients, so that they can find happiness in their daily life?  We help them to find perspective.  We help them to make the most of what they do have.  We put the steps in place to make it easy.

Don’t wait for the markets to improve to find your happiness

There’s what the markets can do for you, there’s what you can do for you and there’s what a Trusted Adviser can do for you.  When the markets are letting us down, focus on what you can do and find out what a Trusted Adviser can do for you.

An investment not worth paying for

When you’re making any purchasing decision, you make a judgement about whether you believe you’re getting value for money.  Along with price, other things that may come into the calculation include convenience, great service or in the case of luxury goods, the perceived effect on your social status.  

But when it comes to money management, the one factor that should not sway the decision is the promise of “great investment returns”.  As alluring as this sounds, we know that this is a very bold promise and you should know how to check if your money manager (read: stockbroker, fund manager or financial adviser) delivers.

So here is a proposition for you:
 

If these stock-picking pros promise great returns, their performance should be measured against the market in which they are investing.  If they are picking Aussie shares for your portfolio, then you should know if they are getting a better return than the market itself.  Why?  Because you can buy the market yourself at a much lower cost!

Don’t get me wrong, these stock-picking professionals are trying to beat the market.  It’s just that it is really hard to do.  You don’t want to pay extra if the result is more due to chance than skill.  And that is what the evidence from Karaban & Maguire (2011) is telling us:  

The S&P/ASX 200 Accumulation Index has outperformed approximately 70% of active Australian equity general funds over the last five years, increasing to approximately 77% over the last year (mid year 2011).  At least 69% of active international equity funds underperformed relative to the benchmark over every time horizon. Over the last year, the index has outperformed approximately 80% of actively managed international equity funds. 

So if the odds of beating the market are that bad, why would you pay more for the promise of better returns? 
 

The Trusted Adviser.

DIY Share Investing: Prudent Management or False Economy?

Now that you know a bit about us at The Trusted Adviser, it's time to ask you a question - if you are a serious do-it-yourself share investor, why are you going it alone?  For many of you, the answer will be “So I don’t have to pay management fees” or it may be about something more fundamental like trust, or a lack of it, in the advice of others.  Whatever the reason, if you are serious about managing your money (and I am guessing that you are), it is essential that you know how you are tracking compared to the performance of the sharemarket index.  Why?  How else will you know if you are doing a good job?  And if you heed this advice, brace yourself, it could be a very humbling experience.

But investing is not just about return. There is the other small matter of risk to consider.  Now you may not agree with me on this, but I reckon hanging your hat on a handful of stocks is risky

• It lacks diversification, and
• It risks significant under-performance compared to the market.

What?  You don’t care if your returns aren’t as good as the market, as long as the return is positive.  If you think that and you’re serious about making money, stop reading now.

For those of you still with me, let’s get back to diversification.

A dozen stocks sounds diversified enough doesn’t it?  And where’s the risk in owning BHP, RIO, the banks, Wesfarmers, Woolies and Woodside?   Shareholders in General Motors thought the same way before the GFC didn’t they? But I hear you saying “GM was having trouble way before the GFC and everyone could see it.  I would never have invested in a stock like that”.  Hhmmmm….Wesfarmers went from $42 to $14 as investors nervously watched them negotiate with their bankers while chewing on a gob-full of debt from the Coles acquisition.  And what about RIO?  $124 to $24 as they carried the can (and debt) from their ambitious acquisition of the aluminium giant, Alcan.

Anyway, enough tripping down memory lane.

Under-performance relative to the market costs real money and that’s ignoring your hours of research.  Wouldn’t it be just a little bit disappointing if you were getting a less-than-market return for all your time and effort?  But I really enjoy it, I hear you protest.

Well if stock picking is one of your hobbies, here’s my advice

1. Pick a relatively small sum to play with – say no more than 10% of your investment capital 
2. Take less risk with the rest (check out our post on trying to beat the market - “An investment not worth paying for”).

financial advice

Our main message here is that successful investing is about only taking risks that are likely to compensate you with added return over time.  It is best summed up by our friends at Dimensional when they say: 

Avoidable risks include holding too few securities, betting on countries or industries, following market predictions, and speculating on “information” from rating services.  To all these, diversification is the antidote.”1

For an academic perspective on diversification, you can also view this video:

The Trusted Adviser