Record numbers of newbies began investing during pandemic lockdowns. However, splashing cash on shares in technology, big-name companies or the latest demographic fad does not guarantee success or strong returns.
But if you screen potential purchases through a filter of these tried-and-tested investment rules, you maximise the chances of generating wealth over the long term – without taking on unnecessary risk.
1. Spread the risk
About the only free lunch in investing is diversification: not having all your eggs in one basket. That way, when one investment is going backwards, others may be firing, making up for your losses.
Diversification means not only spreading money between individual investments in the same asset class, such as shares, but expanding across other asset classes, too.
The amount of time you want to invest your money for is important.
Those with short time-frames – say, fewer than five years, need to be more conservative – says Jonathan Philpot, a wealth management partner at HLB Mann Judd Wealth Management.
Being conservative could mean investments that pay income while the capital is fixed, such as term deposits offered by banks.
Those with longer time frames could include riskier investments, such as shares which are expected to produce higher returns over a longer term, in their investment portfolio.
2. Stick with it
Studies show those who chop and change investments have poorer returns than those who have a firm strategy and stick to it. For one thing, when you change an investment you face the challenge of picking a new investment winner.
While it is tempting to jump onto the latest hot investments in the hope of making quick capital gains, patient investors can often do better by selecting investments that pay high levels of consistent income.
The power of dividends is illustrated by comparing the returns of Australian share prices with the returns after adding in the dividends that many listed companies pay.
CommSec chief economist Craig James says Australian share prices have more than doubled since January 2004, but if the dividends had been reinvested to buy more shares in the companies when they were paid, the total return would have risen almost five times.
3. Return killers
Fees and trading costs can take the shine off the best investments.
Over time, fees and costs compound and gobble-up returns. Major costs include brokerage, which is charged each time a security is bought or sold.
Chris Brycki, the founder of online fund manager Stockspot, says the lower the fee you pay to the seller of investment services – your broker, adviser or fund manager – the more money there is left for you.
“Every dollar you pay in commissions, funds management fees, adviser fees, subscription fees or brokerage come directly out of your returns,” Brycki says.
Any investor ought to be ‘able to explain to an 11-year-old in two minutes or less why you own it’.Peter Lynch, a former manager of the Fidelity Magellan Fund
Exchange-traded funds (ETFs) can be a good way for those starting out to obtain diversification at low cost.
ETF units are traded on the Australian Securities Exchange (ASX). Some track the returns of broad markets, such as the ASX or US share market indices. They allow investors to match market returns cheaply, without having to make selections of individual stocks.
4. Keep it simple
Complexity favours the provider of the investment. It is easier for fees and charges to be hidden when the investment is complex. Simplicity makes the investment easier to understand.
Peter Lynch, a former manager of the Fidelity Magellan Fund, says any investor ought to be “able to explain to an 11-year-old in two minutes or less why you own it”.
And that is true of any sort of investment, not just those you hold directly, whether it is provided by a fund manager or a listed investment company. If you do not understand a financial product, don’t invest in it.
5. Madness of crowds
Countless investment fads have arisen over the years, only to lose investors’ money. Once everyone starts getting on the bandwagon and the fad becomes mainstream, the best is often already over.
AMP chief economist Shane Oliver says it is important for investors to be aware of the role of money psychology and its influence on their thinking.
He says the best defence is to be aware of past market cycles – so nothing comes as a surprise – and to avoid being “sucked into booms and spat out during busts”.
Oliver says the pressure for conformity, such as interaction with friends, can result in a herd mentality among investors.
“If an investor is looking to trade they should do so on a contrarian basis. This means accumulating [investments] when the crowd is panicking, lightening off when it is euphoric,” he says.