Investment Articles

After such a tumultuous year for investors it can be helpful to come back to some basic principles.

Here are five do’s along with five don’ts that we believe are good advice at any time, but especially in the aftermath of the global financial crisis.

Let’s start with the Do’s.

1. Be cautious. Having a conservative bias makes mathematical sense. If you lose 50 percent of your capital you need to earn 100% to get back to square one. This most basic mathematical fact is justification enough for a cautious bias when investing. It is better to miss out on some upside in order to protect your capital against downside.

2. Have realistic return expectations. Over the long haul fixed income investments like deposits and bonds will return between 4% and 7%, while property and shares have averaged returns of 7% to 10% a year.

A balanced portfolio, depending on the mix of assets, might therefore be expected to deliver a return of 6% to 8% a year. After tax and inflation are deducted this return may translate into a real net return of 2% to 3% a year. Not only do returns tend to be lower than people expect, they also often end up being more volatile. Expect returns to be up and down, sometimes dramatically so. Market volatility is an unavoidable part of investing.

3. Diversify. The best way to avoid financial disaster is diversification. A wide spread of high quality investments across sectors, markets and assets is the most effective way of reducing risk. Diversify across time as well. Investing in instalments is a great way of protecting against mis-timing and buying just before a market fall.

4. Invest for income. Owning investments that pay you to own them makes sense. Bond, property and shares all produce income. Capital growth is important, but it usually follows income growth. Buy for income and growth should follow.

5. Take a disciplined approach. Setting some rules around how you will invest your portfolio, such as how much you will invest in riskier options like shares and property and how many you will look to own, is worth the effort. It gives you a roadmap on how to invest your portfolio.

And five don’ts.

1. Don’t ignore inflation. Even if inflation stays at around 2%, it still takes 10% off the spending power of your capital every 5 years. Inflation is every investor’s enemy number one. Over the long term real assets such as property and shares have proven the best protection against inflation.

2. Don’t rely on market forecasts. Humans cannot predict markets with any consistent degree of accuracy. Don’t put too much faith in them. We should spend more time ensuring our portfolios are well diversified than on trying to predict market movements.

3. Don’t buy and hold. Invest for the long term and with the intention of holding your investments for many years but, if things change, be prepared to review and alter your portfolio accordingly.

4. Don’t fall for options that appear too good to be true. At present, the return on a New Zealand government bond, the safest investment of them all, is around 5%. If you want no risk, this is the return you have to accept. Achieving any return above this level will involve taking a degree of risk. And the higher the return you aim for, the more risk you have to take. No exceptions.

5. Don’t invest in anything you don’t understand. If you find yourself struggling to understand an investment it can pay to give it a wide berth. Or at least, invest only a small amount until you learn more and get more comfortable with it.

Craigs Investment Partners Limited (formerly ABN Amro Craigs.) is an NZX Firm that was established in 1984. It is one of New Zealand’s largest and most established investment advisory firms.

Craigs Investment Partners is 100% owned by certain staff and close business associates. Services offered include: Sharebroking, Portfolio Strategy and Management, Retirement Planning and Superannuation, Investment Advisory, Custodial Services, Foreign Exchange, Asset Allocation, Cash Management, Portfolio Lending, Research and such other services as introduced from time to time by Craigs. http://www.craigsip.com/

Personal investing makes the average new investor uncomfortable. I say this because I was a financial planner for 20 years. I found that most people can relax and start investing with more confidence. If, that is, they make money in the process and learn some investment basics… like the difference between stocks and bonds.

You can work with a financial planner or start investing on your own. But when the economy turns sour and you’re losing money, you’ll feel the stress if you don’t know investment basics and have no sound investment strategy. Let’s start our personal investing lesson with investment basics, stocks and bonds.

Stocks are also called equities and they are VARIABLE growth investments. They involve higher risk, but over the long term have historically returned about 10% a year to investors who just buy and hold them. Equities fluctuate significantly in value; hence there is significant market risk here. Bonds on the other hand are FIXED income investments that have the attraction of paying relatively high rates of interest. They are safer and have returned about half as much over the long term. But they too fluctuate in value.

Traditionally speaking, financial planners generally recommend that you invest in both stocks and bonds to get balance in your investment portfolio. That’s the basic investment strategy that’s been recommended to the new investor for years. Often, when stocks are falling bonds are doing just fine and vice versa.

The basic investment strategy: invest 60% in stocks and 40% in bonds to get a moderate balance with overall moderate portfolio risk. That makes personal investing sound pretty simple doesn’t it? And actually it has worked pretty well for years. Just knowing this should boost your confidence and help you start investing with less stress. However, don’t think that this simple strategy will eliminate all stress in this day and age.

This time things could be different because interest rates are at all-time lows with only one way to go in the future… UP. Here’s the problem. Rising interest rates ALWAYS cause the value of bonds to fall. They also hurt stock values as well. With interest rates so low the new investor is tempted to look for higher returns in stocks and bonds.

You’ll need more than just a grasp of investment basics to survive another downturn in the economy. What you really need to get your personal investing ducks in a row is an ongoing plan of action; a sound and complete investment strategy. Then you can start investing with confidence. Check for articles on the subject because investment strategy is that important, especially today.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.

Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com.