Three Investment Myths
Written by Kate McCallum, Multiforte
1. Smart investors should seek to time their entry points to markets and wait for the volatility to clear.
We are hearing this a lot right now as the European crisis dominates market attention. Writing about this in 1979 before one of the biggest bull markets in history, Warren Buffett said: "Before reaching for that crutch (market timing), face up to two unpleasant facts: The future is never clear [and] you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values."
Of course, some people will happily follow Warren Buffett's advice and continue to invest in shares amidst the market volatility. However, many feel very uncomfortable investing in shares in periods of uncertainty.
Either way, a good option is to invest some of your assets in investments that are more stable than shares - which is where bonds (also known as fixed interest) play a role in a portfolio. So, rather than waiting for the volatility to clear, consider reviewing your asset allocation and potentially increasing your allocation to bonds to improve your risk-adjusted returns.
2. An investment expert's role is to spot the best market-beating returns and harvest them before someone else finds out.
Asked about this in 2007, two years before his death, legendary investment consultant and historian Peter Bernstein said it was better to focus on risk than return. "The central role of risk, if anything, has grown rather than diminished," he said. "We really can't manage returns because we don't know what they're going to be. The only way we can play the game is to decide what kinds of risk we're going to take."
This is a critical issue for all investors - yet most people focus primarily on returns. Have you determined how much and what kinds of risk you are prepared to take?
We believe it's vital to clarify your risk tolerance and risk capacity - then construct an investment and superannuation framework that is designed to deliver that outcome.
The key question to ask yourself is: in a market downturn, how much of my money am I prepared to lose? Could I still sleep at night if I lost 10 per cent, 20 per cent, 30 per cent of my asset value?
3. Stock picking is essential to investment success.
The line here is that the key to wealth building lies in analysing individual stocks and buying them based on a forecast about their prospects.
Long-time Wall Street observer and the founder of Greenwich Associates, Charley Ellis, said the truth was actually quite the opposite.
"The best way to achieve long-term success is not in stock picking and not in market timing and not even in changing portfolio strategy," Ellis said.
"Sure, these approaches all have their current heroes and war stories, but few hero investors last for long and not all the war stories are entirely true. The great pathway to long-term success comes via sound, sustained investment policy, setting the right asset mix and holding onto it."
Now, this is not about 'set and forget'. Because things change. Right now, we are seeing significant geopolitical shifts that mean that our experience of the last 10 or 20 years is unlikely to repeat in the next 10 or 20.
What this means for you is that you need to review and adjust your asset allocation and investments at least annually to ensure you manage your risks and make the most of your assets.
So, what should you do right now?
Just two steps can make a significant difference to your wealth:
- Take time over the holiday break to get well-organised and get a financial strategy in place - experience shows that with this one step, you can save on tax and reduce costs, and achieve a significant financial impact
- Before the new year, get a 'health check' on your investments and superannuation - making sure you have a level of risk you can tolerate, and that you're maximising your returns.
