Weather vs Climate

7 Dec 2010 | 3 min read
Written by Kate McCallum, Multiforte
 
Notice how TV stations put finance next to the weather report on the evening news? In each, the focus is what’s happening each day, in which the long-term story gets lost.
 
This focus on the day-to-day and the short-term can often encourage us to make bad decisions that affect our long-term interests.
 
Here's an example: On October 30, 2009, a leading Australian newspaper announced 'Shares Slide on Fears for US Housing' as the Australian share market suffered its largest one-day fall in more than four months after unexpected news of a slowdown in the US housing market.
 
It would be fair for an investor to be worried that the global economic recovery had faltered and to think about getting out of their share investments.
 
But the very next day, the story had changed completely. The same newspaper led with the headline 'US Growth Spurt Puts Market Back on Track'. In this case, the US Commerce Department had reported stronger-than-expected economic growth figures which had helped ignite a marked reversal in sentiment.
 
Now it would be fair for this same investor to change her mind from the day before.
 
However, the next day’s news announced 'More Bad News on the Way' with a renewed fall in share markets following news of a decline in consumer spending.
 
And on it goes. From day to day to day, market sentiment shifts in reaction to news—news about the economy, companies, governments, politics and the wider world. Prices rise and prices fall in response to news, which by definition is unpredictable.
 
Think of it like the weather. One day it's sunny. The next day it rains. A familiar story for Sydneysiders right now!
*ASX-500 Accumulation Index, Jan 1980-Oct 2010; Source: Returns Program
 
The daily news is interesting. But it's like the difference between the weather and the climate. One changes constantly; the other more gradually with patterns over many years. If you want to invest successfully, it's the climate you need to think about.
*ASX-500 Accumulation Index, Jan 1980-Oct 2010; Source: Returns Program
 
What can you do about it? 
 
As with unpredictable weather, when you invest, you can equip yourself for changes in day-to-day conditions while keeping focus on the long-range climate. 
 
Here are just 5 tips:
 
  1. Understand journey and destination risk: Understand how much risk you are comfortable with and ensure your investments align with that. Most discussion when it comes to investing is about returns. Not enough time is spent thinking about risk. When we design portfolios for our clients, we talk about journey risk – which is about being able to tolerate short-term market volatility; and destination risk – which is the risk that you won’t reach your required net wealth destination. While it’s important to acknowledge the journey risk, we believe investors need to focus on the destination risk and the range of long-term, after inflation returns, that their portfolio will achieve.
  2. Maintain a margin of safety: We recommend that you understand not just the likely case scenario, but also the possible worst case outcome for your investments should things go pear-shaped. This helps to ensure you have a margin of safety – a bit like carrying an umbrella when it’s overcast even if there was no prediction of rain.
  3. Consider opportunity costs: Resources are scarce but dreams are not. This means you need to make careful decisions about how you allocate your income and assets. Most investors do not consider opportunity costs – that is, if your income or assets are used in a particular way, then you miss the chance to allocate them in another, potentially more rewarding way. So the opportunity cost of choosing to hold onto an investment which has lost money would be the cost of forgoing another investment. Another example would be the opportunity cost of failing to repay your mortgage due to a decision to buy a new car.
  4. Stay diversified: Many investors end up with most of their money in one type of asset – like just property, or just shares – and some end up with a concentration of funds in a single security, particularly people with company shares. You need a mix in your portfolio so it can withstand a range of outcomes and keep you on track to achieve your goals.
  5. Have a strategic plan: Would you invest in a business that didn’t have a strategic plan? That didn’t have a clear vision or stated goals? Probably not. Yet 75 percent of investors do not have a strategic plan that guides their decision making. To be a successful investor, you need to create a strategic plan for your personal vision, goals and priorities that reduces the risk that you will get caught out by short-term (weather) affects, and increase your chances of achieving your long-term (climate) goals.
Would you like to enhance your investment outcomes? Perhaps it’s time to create your strategic plan. Simply call 02 8209 1607 or email to arrange a time to chat.
Weather vs Climate
tags: News
categories: News