The seven habits of successful investors
Straits Times – A recent report from Allianz Global Investors on “The seven habits of successful investors” addresses concerns and problems commonly faced by retail investors. Here is an excerpt of the seven tips to guide you on your investment journey.
HABIT NO. 1: KNOW YOURSELF AND CHALLENGE YOUR INTENTIONS
Lessons learnt in behavioural finance repeatedly boil down to the one realisation: We still tend to demonstrate prehistoric behavioural patterns that cannot always be rationally explained.
For example, we often view the investment world in a frame, that is, we see what we want to see and may be excluding better alternatives as a result. We tend to follow the crowd or be driven by sentiments that push investors, particularly back and forth between fear and greed.
Aversion to losses is just as typical: We suffer more pain when we make a loss than we enjoy the same amount of gain. This can be dangerous if you leave all you have in a savings account as a result and, in doing so, forgo returns that you urgently need, or if you back off from realising losses and starting again.
“They’re only losses on paper. I’ll wait until share prices are back to where they were when I started and then sell,” is a deceptive mindset.
HABIT NO. 2: YOUR INVESTMENT DECISIONS SHOULD BE GOVERNED BY “PURCHASING POWER PRESERVATION” RATHER THAN “SECURITY”.
“Security” is often seen as synonymous with the absence of price fluctuations.
In seeking security, however, retail investors overlook the risk of losing purchasing power – which is even more unpleasant, considering that interest on savings is virtually zero currently.
If you want to preserve your capital, the minimum requirement for an investment should be “purchasing power preservation”.
Let’s assume you hide $100 under your pillow. Based on an inflation rate of just under 2 per cent each year, you will be able to purchase goods worth only just over $80 in 10 years’ time. Or less than $70 after 20 years.
Seen this way, the biggest risk may be not taking any risk.
HABIT NO. 3: THE FUNDAMENTAL LAW OF CAPITAL INVESTMENT: GO FOR RISK PREMIUMS
Successful investors know that they cannot earn risk premiums without taking risks. The logical explanation: Investments in riskier assets should be justified with the expectation that those investments will generate higher returns over time than other investments with no risk exposure that thus offer less opportunity.
For instance, long historical time series which are available for the US equity market show that taking greater risks on equities has clearly been rewarded over the long term.
From a purchasing power perspective, equities have offered greater security than bonds.
HABIT NO. 4: INVEST, DON’T SPECULATE
Speculating is betting on price movements in the short term. Investing is putting your capital to work over the medium or longer term.
Take European equities for example: If you invested in a broadly diversified basket of European equities over the last 25 years, you earned nearly 8 per cent on average.
If you missed the 20 best days on the equity market – while waiting for better starting prices, for example – you gained less than 2 per cent.
If you missed the 40 best days, you actually incurred a loss of 2.3 per cent a year on average.
This example goes to show that the risk of missing the best days on the capital markets is extremely high.
HABIT NO. 5: MAKE A BINDING COMMITMENT
Investors have three options for making a binding commitment:
•Strategic/long-term aspects should govern allocation to the various asset classes. Decide on a strategic allocation between equities and bonds that suits your risk profile and use it to steer through turbulence in the capital markets. A good guideline for the right amount of exposure to equities in a portfolio is the rule of thumb “100 – age”. So an investor who is 50 years old at present would allocate 50 per cent to equities. Building on this, individual adjustments can then be made.
•The general rule to follow is never to put all your eggs in one basket, so diversify. Historical evidence shows that what earned great returns one year quickly moved to the bottom of the pile one year later. Therefore, invest money broadly, combining equities with bonds – and maybe other segments as well. The “multi-asset” approach makes it possible.
HABIT NO. 6: DON’T PUT OFF TILL TOMORROW WHAT YOU CAN DO TODAY
Billions of dollars are slumbering in savings and bank deposit accounts despite the fact that one of the key drivers of investment success is the compound interest effect.
For example, let’s say an investor wants to have $100,000 at his disposal when he retires. If he starts very early and has 36 years to reach this goal, saving $50 each month is sufficient at an average return of 7.5 per cent. If he has only 12 years to go, he has to put aside $400 each month.
HABIT NO. 7: GO FOR ACTIVE MANAGEMENT
Anyone who opts for active management not only hopes the experts will earn him additional returns, but also exposes himself to less risk of the dead weight of one-time darlings of the equity market cluttering up his portfolio. After all, passive management maps yesterday’s world.
Just think back to when the technology-media telecom bubble burst at the turn of the millennium, or the US housing crisis that had a particularly adverse impact on financial securities around 2008. It is better to counter-steer.
So investing may be easier than you think.
Don’t put it off. Heed habit no. 6.