By Annika Bradley
Investing can be complex, but a little bit of knowledge can go a long way when considering how to invest your hard earned dollars. We’ve come up with three simple, but critically important, investing lessons that will get you started on the right path to being a successful long-term investor.
Cash is good when saving up for something over a few years, as an emergency fund and for grabbing a bargain when shopping. But it’s no good as a long-term investment strategy, no matter how conservative you are.
In recent years we’ve seen falling bank deposit and term deposit rates. Back in 2009 you could open up a five year term deposit with Westpac that paid 8 per cent per annum. Right now, the best available is 3.5 per cent. Online savings accounts’ base rates are closer to 2 per cent – hardly enough to keep up with inflation.
It’s why it’s so important for all investors (including the most conservative) to have a diversified portfolio, including allocations to assets such as shares (both domestic and international), property and infrastructure. For instance, Australian shares have returned 13.5 per cent per annum for the five years to 31 December 2015. This compares with the Australian short term cash index (measured by the Bloomberg AusBond Bank Bill Index) which has returned 4.9 per cent for the same period (source: State Street Global Advisors). If you stuck with cash during that period you’ve been left behind.
Lesson: Conservative means investing in a diversified portfolio of assets, not investing largely in one asset class, even cash. The purchasing power of cash tends to be eroded in the long-term by inflation.
The finance industry is full of spruikers who promise high returns but are really just delivering high risk. While you need to take risk to get decent returns, there’s a point where the alarm bells should start going off!
Investment returns are normally anchored to cash, which is safe and typically pays the lowest return. As you take on more risk, you should expect to earn a return above cash. The best you can get on cash at the moment is 3.5 per cent (and that is only if you are prepared to lock your money up in a term deposit) and we think it’s reasonable to expect around 3.5 per cent above locked-up cash (assuming all goes well) or around 5 per cent above a liquid cash account for shares and other riskier long-term investments. On that basis, 7 to 8 per cent returns are a reasonable expectation on a riskier, but sensible, investment.
Of course you may not get those returns, particularly in an individual year. For example, over shorter time periods, a share portfolio could easily lose or gain 20 per cent (or more).
But by having this figure in mind, you know that any investment promising double digits plus is extremely high risk and, unless you really know what you’re doing, you should stay clear. If you are offered something with a return of 15 to 20 per cent, you should run for the hills. Returns at that level are a sign of a fraud or sham, or simply that the investment has an absurdly high level of risk. If you invest in something where a 20 per cent return is promised, don’t expect to see your money back.
Lesson: If it sounds too good to be true it probably is and the best capital preservation strategy is to walk away from anyone spruiking unrealistically high investment returns.
Many Australian investors have portfolios consisting largely of ASX listed shares. However, around 98 per cent of the world’s share investment opportunities lie offshore. If everything in your portfolio has an Australian focus, you’re missing out on a huge number of interesting companies, industries and locations.
Equally noteworthy, Australia’s share market is concentrated in a few sectors – especially financials, resources and property – and they’re all heavily exposed to the Australian economy. As a result, a portfolio of large cap ASX stocks, or an exchange traded fund (ETF) based on one of the broad share market indices, tends to lack diversification – a reasonable spread of risks among different industries and regions.
Going international means you can invest in a much larger opportunity set – increasing your potential returns. It also means the risks in your portfolio are spread across a larger number of industries than are available in Australia, plus spread across different regions. That gives you better portfolio diversification and improves the chance of achieving your return objectives.
Lesson: Investing internationally can provide greater opportunities, returns and diversification.
It’s never different
You’ve probably heard the expression ‘this time it’s different’ but in the world of investing it rarely is. Remember these three key lessons and you’ll be on the path to good long-term investing results.
Annika Bradley represents the online financial advice service Eviser. This article contains general investment advice only (under AFSL 469838).
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