Sunday, 8 May 2016
Investors cannot be blamed for feeling rattled by the constant flurry of headlines like ‘Major new stock market crash warning’, ‘Economic reality is hitting home’ and ‘NZ growth slows despite migration boom’, but now more than ever is the time to turn down the noise and keep a level head.
Despite some market realities on the international and domestic fronts, like poor dairy prices at home and China’s declining economy causing unease around the world, there are a lot of good things happening and, as they say, adversity always brings opportunity.
Here in New Zealand, tourism is up, migration is incentivising the economy and horticulture is booming.
Given these market conditions and realities, however, there are things that are critical for investors to know and do.
Of course, this is a no brainer – but no less true no matter how often you hear it.
Don’t put all your eggs in one basket as the old saying goes. But plenty do. It seems that common approaches in self managed portfolios are to have one or two high yielding and popular shares and a term deposit. This could potentially leave an investor very exposed to either a very low return or to the possibility of something going wrong in the high yield share they are invested in.
Once you have worked out a strategy that is right for you, it’s important to turn down the noise on the information flow surrounding investment markets. The past couple of decades have seen an explosion in the volume and ease of access to information surrounding economies, financial markets and individual investments. This is great in a way but there is little evidence that it’s helping investors make better decisions and earn better returns.
We seem to lurch from worrying about one crisis after another. Just think about the past year where we saw a long list of worries starting with the US fiscal cliff, then worries about the US Federal Reserve exiting monetary easing too early, the Italian election, the US budget sequester, Cyprus, North Korea, China, etc. In fact, the combination of too much information has turned investing into a daily soap opera – as we lurch from worrying about one thing after another.
Flowing from the last point, the ease with which information on returns can be accessed is likely reinforcing shorter and shorter investment horizons for investors.
An end result of a short investment horizon is an ever higher allocation to perceived safe assets such as bonds and cash/ term deposits. This may have been fine through the GFC and its aftermath, but will ultimately mean locking into lower returns given the low yields now prevailing for bonds and bank deposits. You might say, “at least I won’t lose money on term deposits”, but the point is that low yielding deposits will lock in low returns, making it hard to meet long term financial goals.
There have been lots of investments over the decades that have been sold on promises of high returns or low risk but were underpinned by hope based on hot air (e.g. many dot com stocks in the 1990s, or resources stocks periodically) or financial alchemy where rubbish was supposedly turned into AAA yield generators (the sub-prime CDOs of last decade).
The key is that if it looks dodgy, hard to understand or has to be based on obscure valuation measures to stack up then it’s best to stay away. By contrast, assets that generate sustainable cash flows (profits, rents, interest payments) and don’t rely on excessive gearing or financial engineering are more likely to deliver.
Related to the last point, if an investment looks too good to be true in terms of the return and/or riskiness on offer, then it probably is.
If you do have to trade or move your investments around then remember to buy when markets are down and sell when they are up. This seems like a no brainer, but most people do the opposite. There’s an old saying in investment markets: “flows follow returns”. In other words, inflows are strongest after periods of strong returns and outflows are strongest after weak returns. It should be the other way around.
It’s easy to spend lots to time worrying about an individual share investment or whether to use this fund manager over that fund manager. But the reality is that the key driver of your return is the assets (shares, bonds, cash, property, infrastructure, listed/unlisted, onshore/offshore, hedged/unhedged) that you are exposed to. In other words, asset allocation is paramount and it’s very hard to avoid this.
The well known economist J K Galbraith once observed that there are two types of economists: “those who don’t know and those who know they don’t know”. While that may be a bit harsh, the reality is that point forecasts as to where the share market will be at a particular time or its short term return, have a dismal track record. Good experts will help illuminate and point you in the right direction, but this is what they should be used for.
Many investors miss this. Lots of people have lost money doggedly following some assessment that they were sure would be right.
But the key is to recognise that getting some view right is not what it’s about. What it’s about is making money. Don’t get hung up on extreme views about where markets are going.
For periods of time the crowd can be right and safety in numbers provides a degree of comfort.
However, at extremes the crowd is invariably wrong – whether its lemmings running off a cliff, or investors piling into Japanese shares at the end of the 1980s, Asian shares in the mid 1990s, IT stocks in the late 1990s, US housing and dodgy credit in the mid 2000s. The problem with crowds is that eventually everyone who wants to buy will do so, and then the only way is down (and vice versa during crowd panics). As Warren Buffet once said, the key is to “be fearful when others are greedy and greedy when others are fearful”.
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