Everyone would love to have a crystal ball to tell us what will happen in the world of investments.
Knowing when to expect ups and downs in the market and being ready to act accordingly would certainly make it far easier to strike it rich quickly. But the truth is, with investments, it’s like the story of the tortoise and the hare… slow and steady wins the race.
We have some important rules to consider to help you stay focused and keep building your investments to create a secure financial future for the years to come.
Take advantage of compound interest
When your investments are producing positive results, one of the best ways to maximise your wealth building capacity is to reinvest the proceeds. If you don’t require all of the income generated by your investments for spending, it is a wise choice. Each time you reinvest you are building your capital, and over time the compounding interest will make a significant difference to the value of your overall investment portfolio.
The earlier you can start leveraging compound interest, the better your results will be in the years to come. For example, if you start investing in your 20s or 30s and maximise your compound interest, by the time you reach retirement you should be in a very secure financial position.
Gavin Colosimo, Senior Adviser, explains,
“It’s important to leverage the power of reinvesting… as opposed to withdrawing the income from the investments and spending it. When you run a comparison of those two scenarios you can really show the strength of compound interest.
There’s no quick, magical recipe to get rich… investing and building your wealth is about making continual smart decisions over a long period of time.”
Consider investment cycles
Astute investors understand that all investments and asset classes go through cycles of boom and bust. The cycles can fluctuate in length, but they are unavoidable. The role of a financial adviser is to understand where those sectors or asset classes are in within their cycle. Gavin says,
“It’s critical that we don’t buy too late in the cycle and pay too much for an investment. Even if it is a really good investment… if we pay too much for it, our longer-term returns can be diminished. We have to recognise where we are in the cycle and buy at the right time.
This is where our investment committee provides a lot of guidance. They give us information about where cycles are sitting, and we help investors make decisions based on that information.”
It’s important to have a long-term focus when investing, as when you’re focussed on a long term result you are less concerned by the shorter term fluctuations that occur in investment cycles. There tends to be more risk involved when only investing for a short period of time because trying to make large gains quickly creates volatility. Gavin recommends that clients commit to at least eight to ten years:
“As we’ve said, investment goes in cycles, so there’s a lot more risk in investing in the short term, especially if you have a set return in mind. When you invest over a longer timeframe, each asset class will generally perform in a more consistent way. Over just three to four years there’s no guarantee that you will achieve the longer-term average.
By investing for longer, you minimise the risk of inconsistency.”
There’s a well known saying – ‘don’t put all your eggs in one basket’ and this is where diversification is key.
At any given time, different investments or asset classes will be either high or low within their cycles. If you were to have your investments in one single asset or asset class, you risk experiencing significant swings in your returns.
Gavin discusses how you can balance your returns:
“We don’t want to be on a roller coaster ride depending on what an individual asset class is doing. By investing in different asset classes across a range of investments, you can achieve much better stability.
If at one time one investment isn’t doing well, it’s likely that at the same time another asset class could be doing much better… for example, if the share market is doing poorly, generally, fixed interest investments or gold are performing well. So, if we have a balance of investments in your portfolio… we can smooth out the bumps over the long term.”
Understand the difference between news and noise
There is always a lot of information being supplied by many different sources… but it’s important that you recognise that not all news is worthy of the attention it receives and you definitely don’t want to base investment decisions on this information.
The media’s job is to sensationalise. The truth is, hype and fear get far more clicks or papers sold than steady growth and good returns.
“You will often see articles about the financial markets that are focused on the negative … for instance a headline might be ‘$1 billion wiped off today’… but there was no report telling you about the $1.5 billion that the market put on during the two weeks before.
It’s important that clients understand the snippets they get, especially from the normal news outlets, are going to be exaggerated in order to get viewers or readers.”
Avoid the crowds
Hearing about a new buzz investment can certainly be motivating but jumping on board the latest ‘sure thing’ isn’t necessarily a good idea. Gavin explains,
“There can often be a bit of a herd mentality when it comes to ‘the next big thing’. Some recent examples that illustrate this include the IT dot com boom in the late 1990s and 2000s and the Bitcoin peak when it reached up to $20,000. Once the word gets out, lots of people buy up late in the run.
With the IT boom, many of these companies didn’t necessarily have any fundamentals behind them… they weren’t making any money… in fact it’s quite similar to Tesla in the current market. Lots of people think electric cars are the next big thing so lots of investing is happening… but the company is yet to turn a profit.
These are the types of investments that people need to be wary of… if it sounds too good to be true, it normally is!”
Ask for help
Building an investment portfolio can be a complex exercise. We recommend seeking advice from a qualified financial adviser to help steer you in the right direction.
At First Financial we understand that it’s about educating our clients to help them understand fundamental investment concepts and remove the emotional aspect from their financial decisions.