10 Things to Consider When Looking at Investments

 

After such a tumultuous year for investors it can be helpful to come back to some basic principles.

Here are five do’s along with five don’ts that we believe are good advice at any time, but especially in the aftermath of the global financial crisis.

Let’s start with the Do’s.

1. Be cautious. Having a conservative bias makes mathematical sense. If you lose 50 percent of your capital you need to earn 100% to get back to square one. This most basic mathematical fact is justification enough for a cautious bias when investing. It is better to miss out on some upside in order to protect your capital against downside.

2. Have realistic return expectations. Over the long haul fixed income investments like deposits and bonds will return between 4% and 7%, while property and shares have averaged returns of 7% to 10% a year.

A balanced portfolio, depending on the mix of assets, might therefore be expected to deliver a return of 6% to 8% a year. After tax and inflation are deducted this return may translate into a real net return of 2% to 3% a year. Not only do returns tend to be lower than people expect, they also often end up being more volatile. Expect returns to be up and down, sometimes dramatically so. Market volatility is an unavoidable part of investing.

3. Diversify. The best way to avoid financial disaster is diversification. A wide spread of high quality investments across sectors, markets and assets is the most effective way of reducing risk. Diversify across time as well. Investing in instalments is a great way of protecting against mis-timing and buying just before a market fall.

4. Invest for income. Owning investments that pay you to own them makes sense. Bond, property and shares all produce income. Capital growth is important, but it usually follows income growth. Buy for income and growth should follow.

5. Take a disciplined approach. Setting some rules around how you will invest your portfolio, such as how much you will invest in riskier options like shares and property and how many you will look to own, is worth the effort. It gives you a roadmap on how to invest your portfolio.

And five don’ts.

1. Don’t ignore inflation. Even if inflation stays at around 2%, it still takes 10% off the spending power of your capital every 5 years. Inflation is every investor’s enemy number one. Over the long term real assets such as property and shares have proven the best protection against inflation.

2. Don’t rely on market forecasts. Humans cannot predict markets with any consistent degree of accuracy. Don’t put too much faith in them. We should spend more time ensuring our portfolios are well diversified than on trying to predict market movements.

3. Don’t buy and hold. Invest for the long term and with the intention of holding your investments for many years but, if things change, be prepared to review and alter your portfolio accordingly.

4. Don’t fall for options that appear too good to be true. At present, the return on a New Zealand government bond, the safest investment of them all, is around 5%. If you want no risk, this is the return you have to accept. Achieving any return above this level will involve taking a degree of risk. And the higher the return you aim for, the more risk you have to take. No exceptions.

5. Don’t invest in anything you don’t understand. If you find yourself struggling to understand an investment it can pay to give it a wide berth. Or at least, invest only a small amount until you learn more and get more comfortable with it.

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