The 9 most important things I have learned about investing over 40 years

The period started with deregulation and globalisation but is now seeing re-regulation and de-globalisation. It’s seen the end of the Cold War, US domination and the rise of Asia and China but is now giving way to a new Cold War... and so on. 

But the more things change the more they stay the same. And this is particularly true in investing. So, here’s an update of the nine most important things I have learned over the past 40 years.

#1: There is always a cycle – stuff happens!

#2 The crowd gets it wrong at extremes

These include the tendency to project the current state of the world into the future, the tendency to look for evidence that confirms your views, overconfidence, and a lower tolerance for losses than gains. While fundamentals may be at the core of cyclical swings in markets, they are often magnified by investor psychology if enough people suffer from the same irrational biases at the same time. 

From this, it follows that what the investor crowd is doing is often not good for you to do too. We often feel safest when investing in an asset when neighbours and friends are doing the same and media commentary is reinforcing the message that it’s the right thing to do. 

This “safety in numbers” approach is often doomed to failure. Whether it’s investors piling into Japanese shares at the end of the 1980s, Asian shares in the mid-1990s, IT stocks in 1999, US housing and credit in the mid-2000s.

#3 What you pay for an investment matters – a lot!

Flowing from this, it follows that yesterday’s winners are often tomorrow’s losers – as they get overvalued and over-loved. But many find it easier to buy after shares have had a strong run because confidence is high and sell when they have had a big fall because confidence is low.

#4 It’s hard to get markets right

Usually the grander the forecast – calls for “great booms” or “great crashes” – the greater the need for scepticism as such calls invariably get the timing wrong (so you lose before it comes right) or are dead wrong.

They may be right one day, but an investor can lose a lot of money in the interim. The problem for ordinary investors is that it’s not getting easier. The world is getting noisier with the rise of social media which has seen the flow of information & opinion go from a trickle to a flood and the prognosticators get shriller to get clicks. 

Even when you do it right as an investor, a lot of the time you will be wrong – just like Roger Federer who noted that while he won almost 80% of the 1526 singles matches in his career, he won only 54% of the points, or just over half. It’s unlikely to be much better for great investors. For most investors, it's best to focus on the long-term trend in returns – ie, the green line as opposed to the blue line in the first chart.

#5 Investment markets don’t learn, well not for long!

But it does! Often just somewhere else or in a slightly different way. Sure, the details change but the pattern doesn’t.

#6 Compound interest is key to growing wealth

Although the average annual return on Australian shares (11.6% pa) is just double that on Australian bonds (5.6% pa) over the last 124 years, the magic of compounding higher returns leads to a substantially higher balance over long periods. Yes, there were lots of rough periods along the way for shares, but the impact of compounding returns on wealth at a higher long-term return is huge over long periods. The same applies to other growth-related assets such as property. So, to grow your wealth you need to have a decent exposure to growth assets.

#7 It pays to be optimistic

Since 1900, the Australian share market has had a positive return in roughly eight years out of ten and for the US share market, it’s roughly seven years out of 10. So, getting too hung up worrying about the two or three years in 10 that the market will fall risks missing out on the seven or eight years when it rises.

#8 Keep it simple, stupid

But when we overcomplicate things we can’t see the wood for the trees. You spend too much time on second-order issues like this share versus that share or this fund manager versus that fund manager, or the inner workings of a financially engineered investment so you end up ignoring the key drivers of your portfolio’s performance – which is its high-level asset allocation across shares, bonds, and property. Or you have investments you don’t understand or get too highly geared. 

So, it’s best to keep it simple, don’t fret the small stuff, keep the gearing manageable and don’t invest in products you don’t understand.

#9 You need to know yourself

If you don't have the time and would rather do other things like sailing, working at your day job, or having fun with the kids then it may be best to use managed funds or a financial planner. It’s also about knowing how you would react if your investment just dropped 20% in value. 

If your reaction was to be to want to get out, then you will either have to find a way to avoid that as you would just be selling low and locking in a loss or if you can’t then you may have to consider an investment strategy offering greater stability over time and accept lower potential returns.

What does all this mean for investors?