MLC Market Watch

By MLC Market Watch Team

16 Mar 2009

Six golden rules of investing

As part of our monthly Market Watch video series, MLC Senior Investment Specialist Natalie Comino presented six golden rules of investing.

Here’s the transcript from her video:

Golden rule number one is never lose sight of the fact that risk and return are related. This is easy to do when we’re in a bull market and double-digit returns are taken as the norm. However if you are looking for higher returns, you have to be willing to take on more risk. This means the value of your investment could change dramatically over a short period of time. The higher this volatility, the riskier these types of assets are.

Over the long term, growth assets like shares and property are expected to earn higher returns. But these investments will be more volatile so you will need a long time horizon and a strong stomach to ride the ups and downs you’ll experience. If you’re not prepared for this, then you might want to consider a more conservative strategy or assets that are expected to earn lower returns but are usually more stable performers, like cash and debt securities.

Golden rule number two is diversify, diversify, diversify! This means having a broad range of investments in your portfolio. It’s a great way of reducing the volatility of your investment. Diversifying across asset classes like shares, property, cash and debt securities can substantially reduce volatility but we don’t stop there. At MLC we diversify across asset classes, within asset classes and across investment managers.

Diversifying your investment in this way helps reduce the ups and downs of investing. That’s because the strong performance of one asset class or investment manager can compensate for the weak performance of another. Of course, no one can get every call right every time, and no one type of investment performs well in every market. So diversification helps us manage risk and achieve smoother long-term returns for our investors.

Golden rule number 3 is use skilled investment managers. Inevitably when markets tumble, quality investments are thrown out with the bad as some investors are forced to sell assets to meet borrowing and other financial commitments. These are ideal conditions for skilled investment managers to purchase quality assets at “fire sale” prices. Good investment managers use volatile and uncertain market conditions to lay the foundations for future strong long-term returns. At MLC, we take a multi-manager approach to investing. That means we bring together some of the best managers in the world who can select the best investments for our funds.

Golden rule number 4 is set an investment strategy and stick with it, as long as your objectives don’t change. In reality, all growth-focussed investors will experience negative returns at some stage. But if we look back through history, we can clearly see economies and markets have recovered from every catastrophe and carried on growing. So by sticking to your strategy you are much more likely to do better over time than by chopping and changing.

This is, of course, easier said than done. A Boston-based financial research organisation called DALBAR studied US investor behaviour over a twenty-year period. They found the average US investor in US equity funds earned only 4% per annum over the period 1986 – 2006, while the broader US sharemarket, as measured by the S&P500 Index, earned 12% per annum. Why did investors do so much worse than the market? Because they didn’t stick to their plan. They sold when the market fell and bought back in after markets had improved. In doing so they committed the ultimate mistake when investing: they sold when prices were low and bought when they were high. So it’s worth remembering that while we can’t control the market, we can control our own behaviour.

Golden rule number 5 is that time in the market and not timing the market is what matters. Many people make the mistake of trying to time the market – hoping to sell before a market fall comes, or waiting to buy at the lowest price. But this is a high risk strategy and very easy to get wrong because markets are unpredictable on a day-to-day basis. Over the long-term though, sharemarkets are more predictable and from a historical perspective have steadily trended upwards.

Therefore by staying invested and not trying to predict the peaks and troughs, you can usually grow your investments over the long term more successfully. If you sell your investments to try and miss the worst of the downturn, you will not only turn paper losses into actual losses, but you may also miss the market recovery when it happens.

My final golden investment rule is to get good financial advice. Making the right decisions in times like these is challenging. But a good financial adviser can provide guidance so you don’t make decisions that could harm your financial wellbeing. They will help you work out your long-term financial goals and assess your appetite for risk, so together you can set a financial plan that will see you through all markets. If over time your circumstances change, or you feel increasingly uncomfortable with your risk profile, a financial planner can alter your strategy with you.

To sum up, our golden rules for investing in turbulent times are:

Remember risk and return are related
Diversify, diversify, diversify!
Use skilled investment managers
Set an investment strategy and stick with it
It’s time in the market and not timing the market that matters
Get good financial advice.

Thanks for your time.

General Advice Warning:

These comments contain general information and may constitute general advice. They do not take into account and person’s particular investment objectives, financial situation or individual needs. They should not be relied upon as a substitute for financial or other specialist advice.

Before making any decisions on the basis of these comments, you should firstly, consider the appropriateness of its content having regard to your particular investment objectives, financial situation or individual needs and secondly consider the relevant Product Disclosure Document.

Opinions expressed constitute our judgment at the time of issue and are subject to change.