Robert Allen once said “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case, so we know we need to invest in something to get ahead but what do we invest into?
When it comes to investments there are really only 4 categories that pretty much everything fits into:
The first two are Businesses and Property.
- Businesses can be divided into several categories; from your own business, to other peoples’ businesses, both large and small, private and public.
Now if we invest in a public company listed on the Stock Exchange, we call these shares because we have a share of the ownership of that company. If you have shares in BHP, you OWN a share of BHP and you get a share of BHP profits.
- Property has many different categories; from residential to commercial to industrial to tourism and more.
These two categories we would group together and call GROWTH INVESTMENTS. That’s simply because as well as getting income (dividends from our shares, and rent from our properties) – we also hope that they – what will happen to their value? … Yes – we expect them to GROW
- Then we have loans. Loans are simply how we lend money to someone. When we put our money in a bank account we are simply lending it to the bank.
There are lots of different types of loans, with different names – bonds, debentures, bank bills – but they are all just simply loans.
We get some income, which we call INTEREST, and we hope that we get our capital back, but a loan doesn’t grow in value apart from the income.
- Everything else can be catergorised as “Stuff”. The first three categories all would be expected to produce income, but with stuff we are really holding it hoping that the price will go up, and we can sell it to someone else at a higher price. Take a piece of gold bullion or a work of art. On their own, they don’t produce any income, so the only gain we can make is if the value goes up. Now that’s how I would define speculation, rather than investment. And what we are focussing on today is investment and how investors mess it up and make bad decisions.
What you choose is a personal preference but if we have included a little guide of things to look out for so you don’t MESS IT UP!
M = Media. The media is in the business of selling newspapers and news bulletins by spreading negativity and bad news stories. The media understand that the ratio of fear to greed is four to one; in other words, you are four times more likely to act out of fear to protect yourself than because of greed. The next time you hear a negative media story about the share market think to yourself ‘how often do you hear a good story about the share market where everyone made money and the market went up?’ The reality is that positive stories and up markets don’t sell newspapers, and this is why they are rarely told. So it is important that you are consciously aware to not get caught up in the hype of the bad news story of the day when it happens.
E = Emotion. No one likes to hear bad news. It’s not what happens to you, but how you respond to it that makes all the difference when it comes to investing. The best advice we can give you when it comes to investing is this: Always make logical, calm, calculated investment decisions with both a long term and short term perspective and never make an investment decision solely based on your emotions or a reaction to a market drop or market increase.
Consider different times in history, for example the 1987 stock market crash during the Hawke/Keating era, the large increase in the share market from 2001-2007, and the 2008 Global Financial Crisis. There will always be ups and downs; however it is important that your emotion does not lead to one of the three big mistakes and Dalbar.
The first S in MESS = Short term focus. We never allow our clients to focus on the short term or the latest and greatest share or managed fund. We know that this quarter’s star performer has proven time and time again to be next quarter’s underperforming share or managed fund. Wayne Gretzky, the famous goal scoring Canadian ice hockey player, was interviewed and asked how he was able to consistently score so many goals in the National Ice Hockey League. He said, “That’s easy. Most people skate to where the action is now. I don’t do that; I skate to where the puck is going to be”.
Follow this analogy from Gretzky to say that we don’t focus on what’s hot in the stock market right now or focus on the short term; we focus on where your investments are going to end up in the future. This is one aspect of value is that investing is to long term – it’s all about creating a great future for you.
The last S in MESS = Single issues. Many investors get caught up on one issue and how this will affect the whole world, for example the European crisis, the current oil price, the price of GOLD, or what the US president said or what the neighbours or their friends said. It’s always important to have perspective and to assess each individual issue and consider whether it may or may not have relevance in the grand scheme of things.
We move onto the “IT” in MESS IT UP
I = Illiquidity in our portfolios. Not having enough cash reserves makes you vulnerable. Suddenly selling down shares to obtain cash creates what is called a sequencing risk. Sequencing risk is also known as the reverse effect of dollar cost averaging.
T = Timing is all about ‘time in the market’ not ‘timing the market’; in other words, those people who look for the ‘best time’ to buy shares or when should I be buying shares at the best price? Our view is that anytime is a good time, as we use a strategy called dollar cost averaging where you invest into the market little by little. If the market is going down you are buying shares at a cheaper price and if the market is going up, you are not paying as much on the way up.
We move onto the “UP” in MESS IT UP
U = Under-diversification. Under-diversification means to invest in a few individual companies only and hope they perform well. Your investment success is then tied to their success, which we believe is not a sound strategy. Having a diversified portfolio across many different companies simultaneously is a good strategy. If, for example, one company fails and 299 do well, then the investor has gained overall and is in a less vulnerable position than if they invested only in the one company that failed. “ Diversification is simply bargaining the right of making a killing in the short term in order of not being killed in the long term”
P = Performance. When we speak of performance we believe that a long-term market return is acceptable, as we are not trying to out-perform the market.
The old school market proposition of picking stocks or investment managers who consistently out-perform the market is not a real or sustainable value proposition. Consistent market out-performance is largely non-existent and can lead to Dalbar-type behaviour when the markets drop and investors panic and sell.
Ultimately, we believe that 50% of investment returns are based on investor behaviour; 45% of investment returns are based on asset allocation; and 5% of investment returns are based on timing and selection.
Traditional investment theory would say it’s 90% asset allocation and 10% timing and selection and it has nothing to do with investor behaviour; however Dalbar research into investor behaviour tells us otherwise