Fundamentals of investing
DON’T FEAR VOLATILITY: HISTORICALLY, MARKET SHARES OUTPERFORM CASH INVESTMENTS
Risk is real, but to be fear-driven leads to bad portfolio management.
An investment portfolio should be produced and managed to balance investment risk with investment returns (rewards) to achieve a more favourable result over your investment horizon. Possibly the greatest reason for not achieving an investment goal is an investor’s reaction to market volatility.
Humans have an ingrained ‘“ight or flight” instinct – which can often cause us to behave in a detrimental way regarding our investments.
In turbulent economic times, investors often regard market downturns as a loss, rather than an opportunity and consider market upturns with over-confidence, rather than with cautious optimism.
This is called the “fear-greed” cycle, where investors choose to invest near the peak of a market and disinvest when markets fall, while emotions take control of their investment decisions.
Global and local investment markets had a torrid five years ending 2018.
Growth assets (shares and equities) under-performed versus cash for only the sixth time since 1900 on a rolling five-year analysis.
Graph 1 shows if an investor had held his money in cash in the five-year period, he’d most likely have generated more favourable returns that if he’d remained in a diversified equity portfolio.
However, over any six-year term, his equity portfolio would out-perform a cash investment.
Over a 25-year investment period,
Main aim of investing is to beat inflation.
his cash investment would generate returns of inflation +1% per year and his equity portfolio of inflation +8% per year.
This is the difference between his money doubling every 72 years (in a cash portfolio) versus his money doubling every 9 years (as would be the case in an equity portfolio).
Beating inflation
The main aim of investing is to beat inflation. Investors can invest in (i) shares or equities, (ii) property, (iii) bonds and cash, or (iv) a combination.
Historical data reveals an investor can expect before-tax investment returns of inflation +1% from cash and inflation; +2% from bonds; inflation +4% from property; and inflation +6% from shares.
The greater the risk, the greater the investment reward.
However, remaining steadfast in market volatility and focused on long-term goals are key to such an investment strategy’s success.
Gareth Collier is a director and shareholder at Crue Invest