Whether you are young and ambitious, or older and newly serious about building wealth, there are lessons to follow that can help. AMP Chief Economist Shane Oliver recently wrote of the things he has found to be the best guiding principles to investing over forty years.
Oliver’s first observation is that things always move in cycles – economies, share markets, property markets, politics. Good times will be followed by problems, and crises will be followed by better times again.
The business cycle is usually three to five years. Some cycles are longer, up to ten years or more in share markets. Ultimately there is no “new normal” or “new paradigm”. Things swing back the way they were.
Oliver also says the crowd gets things wrong at the extremes. Markets become irrational. When things are going really well, or really badly, most people predict more of the same. Their emotional responses make the highs and lows more exaggerated.
The crowd will be wrong, the cycle will start to turn back the other way. Smart investors can win at the extremes by doing the opposite of the masses. When prices are depressed it’s a good time to buy cheaply. When prices are unexpectedly high it’s a good time to sell, values are likely to reverse.
Another key principle that many investment experts emphasize is the power of compound interest. Oliver compares investing in government bonds versus shares in Australia since 1900. Bonds earned 5.6 per cent per annum. Shares returned 11.6 per cent annually, just over double the rate.
One dollar invested in bonds since 1900 would now be worth $924. A dollar in shares for the 124 years would be worth $$879,921. That is an extremely long time, but the principle means that even a couple of per cent higher return for ten or twenty years will make a huge difference at the end.
The investments that will earn the higher returns are growth assets such as shares and property. They will fluctuate more, so it’s essential to invest for the longer term. It’s also important to understand what we are investing in, don’t buy just because it sounds fantastic.
To succeed at investing we need to be optimistic. We must believe things will work out well most of the time – debtors will repay, companies will grow profits and dividends, tenants will pay their rent. We mustn’t be put off by the odd occasion when things don’t work out.
In the modern world it’s also important to ignore the sensational headlines. Turn down the noise. Scary statements attract readers but are usually grossly exaggerated. Finally, don’t be afraid to ask for experienced, professional advice.
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