Home' News Bulletin : ADA News Bulletin July 2015 Contents 41
The investment landscape over the past few years has been
interesting to say the least. The voracious chase for yield continues
as does the volatility in equities and record low RBA cash rates.
As many investors scratch their heads as to how to make money
in this market, I wanted to take a step back and revisit some key
investment principles which are just as important as getting the
best returns from your investments.
#1 – THE POWER OF COMPOUNDING RETURNS
Compounding refers to the concept of earning returns on your
returns. In the current climate, after tax and inflation, the actual return
on just earning interest is often negative. Compounding your returns
by reinvesting those returns allows you to build a more substantial
investment over time. Allowing investments to grow over a long
time frame means returns on reinvested amounts can often exceed
the returns on the original investment. Investments in growth assets
like shares and property can illustrate this fact because the capital
appreciation (capital gain) is allowed to compound without the effect
of the tax man taking his portion each year.
#2 – RISK AND RETURN ARE ALWAYS LINKED
Although this is the fundamental rule of investing, many investors
fail to grasp the relationship between risk and return. In order
to achieve higher returns you need to be prepared to accept a
higher level of risk. Every investment has a degree of risk and
there are different types such as losing some or all of your money,
not achieving the return you expect or not being able to access
your money when you need it. Investors who avoid risk expose
themselves to another type of risk – not being able to achieve their
investment goals. Balancing the need for higher returns with the
need for security of your investments is a challenge for all investors.
Somewhere in the range between 100% defensive or safe assets
and 100% growth or more volatile assets is the ideal portfolio for
each individual investor. The key is to find the right balance that lets
you both achieve your financial goals and sleep at night.
#3 – DIVERSIFICATION REDUCES RISK
Diversification or the concept of spreading your investments across a
number of different investments as well as across different types of
assets is the simplest way to reduce investment risk. Different types
of investments tend to perform differently to each other depending
on the prevailing economic and financial conditions. Asset classes
are often classified into growth or defensive investments. Growth
investments have a greater potential to grow in value but a greater
potential to fall in value. Defensive investments usually maintain
more stable values and provide most of their returns in the form of
income. Shares and property are generally considered growth assets
and fixed interest and cash are considered defensive.
Investing in shares in ten different companies will generally result
in lower risk than investing in one company – especially if the
companies are in different industries or countries. Investors seeking
lower risk through diversification need to understand that different
investments will perform differently in different market conditions
and the only way to reduce your risk of over exposure to one asset
class is to diversify across different types of assets. It is important
to have the right mix of assets that suits your needs as well as
good diversification within those assets classes.
#4 – INVESTMENT VALUES CAN BE VOLATILE – CONSIDER DOLLAR
The fluctuation in value of your individual investments occurs to
varying degrees. Usually the greater the potential return the greater
the volatility and potential for losses should you need to access your
money when values are down. One way to mitigate the effects of
volatility is to undertake dollar cost averaging, a simple investment
concept where investments are made on a regular basis regardless
of what is happening to asset prices. Over time you average out the
cost of your investment as its value fluctuates so you reduce the risk
of getting the timing wrong. If you invest the same amount each
time you get more of the investment when prices are down and less
when the prices are high. This is both a very effective strategy and a
great way to develop a disciplined regular investment program.
#5 – TIME IN THE MARKET VERSUS “TIMING” THE MARKET
It is virtually impossible to correctly and consistently time share
market movements. Time is particularly important with more
volatile growth assets such as shares because the more volatile the
investment the greater the time required to ride out any possible
downturns in investment value and maximise long term returns.
#6 – INVESTING IN LAST YEAR BEST RETURNING ASSETS CLASS IS A
Many investors invest in last year’s best performing asset class and
all too often they are investing too late because no one asset class
is consistently the best performer. You’ll often find investors who
have chosen high concentrations of fixed interest and cash over
shares because these assets classes performed well last year and
will not move back into shares until they are the best performer.
By then much of the upward move in share prices will have taken
place and the risk will be much higher.
Sometimes it’s easy to lose sight of the bigger picture when
investing in such a dynamic and difficult investing environment,
particularly when you’re busy with your day jobs. These principles
should form part of your larger framework when managing your
wealth, whether or not you do this with the help of an adviser.
To the maximum extent permitted by the law, 2020 DIRECTINVEST Pty Ltd
(AR 336649) disclaims liability for errors in, or omissions from, this article.
In no way should this article be construed as providing securities advice
or an endorsement or recommendation of any security or product. In
preparing this article we have not taken into consideration your investment
objectives or your investment needs and make no representation as to the
suitability or otherwise of any product, or security, to you. Thomas Bignill is
the CEO of Mason Stevens Group, which includes 2020 DIRECTINVEST.
For more information or any questions please contact Thomas Bignill on
1800 352 021 or visit 2020’s website on www.2020directinvest.com.au/ada
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