In the investment world, COVID-19 (coronavirus) could be considered a ‘Black Swan’ event, derailing the best laid plans of many investors. As we begin to emerge from the initial economic shock, AMP Capital chief economist and head of investment strategy Dr Shane Oliver shares his tips on what to remember when investing during the recovery.
1. Make the most of compound interest
One of the best ways to build wealth is to take advantage of the power of compound interest. But to do so effectively, you need to make sure you have the right asset mix in your investment strategy. History tells us that if you want to grow your wealth, you won’t do it in bank deposits but are more likely to do it in assets that are connected to the real economy, and will move with the economy over long periods, like shares. As the chart below from Bloomberg and AMP Capital shows, the magic of compounding higher returns over long periods leads to a substantially higher balance over long periods.
2. Beware of the investment cycle
Bonds, shares, property, infrastructure; whatever the investment, they all go through cyclical phases of good times and bad. Some are short-term, such as occasional corrections. Some are medium-term, such as those that relate to the three-to-five year business cycle. Some are longer, such as the swings in sectors seen over 10-to-20 year periods in shares. The trouble is that cycles can throw investors out of a well-thought-out investment strategy that aims to take advantage of long-term returns, and can cause problems for investors in, or close to, retirement.
3. Think long-term
Formulate a long-term plan that suits your level of wealth, age, and tolerance for risk and volatility, and stick to it. This may involve a high exposure to shares and property when you’re young or have plenty of funds to invest (such as when you’re in retirement providing you have your day-to-day needs covered). Alternatively, if you can’t afford to take a long-term approach or can’t tolerate short-term volatility, then it’s worth considering investing in funds that target a particular goal and do the heavy lifting for you. The chart below from AMP Capital shows how – over a long time period – shares have continued trending up, despite the occasional setback.
As the old adage goes, “don’t put all your eggs in one basket” or you could be exposed to a very low (or negative) return if something goes wrong. Different asset classes fluctuate in performance when compared to one another over time but trying to pick such swings is almost impossible. So, the trick is to have a diversified portfolio. But don’t over diversify – this brings the risk of over-complicating your investments for no benefit.
5. Turn down the noise
After having worked out an investment strategy that you’re comfortable with, it’s important to turn down the noise on the information flow surrounding investment markets so you can remain focused. In the digital world we now live in, this is getting harder and harder to do thanks to the 24-hour news cycle. But remember that a lot of the information and opinion (especially online) that feeds the cycle is of poor quality. All it creates is heightened uncertainty and shorter investment horizons which add to the risk that you could be thrown off your investment strategy. This is especially important in the period of COVID-19.
6. Buy low and sell high
What you pay for an investment matters a lot in terms of the return you will get. The cheaper you buy an asset the higher its prospective return will likely be and vice versa, all other things being equal. Selling after a big fall, when fear takes hold, only locks in your losses, so try to buy when markets are low and sell when they are high.
7. Beware of the crowd
While being part of the crowd can make us feel safe, at the extreme highs and lows of the share market the crowd is usually wrong. Whether it was Asian shares in the mid 1990s, IT stocks in the late 1990s, US housing and dodgy credit in the mid-2000s or, more recently, cryptocurrencies like Bitcoin, the problem with crowds is that eventually everyone who wants to buy will do so and then the only way is down (and vice versa when the crowd panics). In the words of investment legend Warren Buffett: “be fearful when others are greedy and greedy when others are fearful”, and as illustrated below, these are usually considered the best times to sell – in the case of the former – or buy, in the case of the latter.
8. Stick to what you understand
If an investment looks dodgy, is hard to understand, or has to be based on obscure valuation measures to stack up, then it’s best to stay away. There is no such thing as a free lunch in investing – if an investment looks too good to be true then it probably is. By contrast, assets that generate sustainable cash flows (like profits, dividends, rents, interest) and don't rely on excessive gearing or financial engineering are more likely to deliver.
9. Seek advice
Investing isn’t easy, and human nature can often run counter to smart investment decisions, so it’s worthwhile using the services of a financial adviser in much the same way as you might use a specialist to look after other aspects of your life, like the plumbing or your medical needs. It pays to shop around to find an adviser you’re comfortable with and can trust.
Oliver’s Insights – 10 medium to longer-term implications from the coronavirus shock26 May 2020 | Grow my wealth AMP Capital's Chief Economist, Shane Oliver, looks at what COVID-19 means for the economy and investment markets Read more
Oliver’s Insights – The coming surge in Australia’s budget deficit and public debt due to Coronavirus – can we afford it?13 May 2020 | Grow my wealth AMP Capital's Chief Economist, Shane Oliver, looks at how the Australian Government will pay for its coronavirus response Read more
Oliver’s Insights – The Lucky Country - three reasons why Australia may come through this period of global misery better than most countries06 May 2020 | Grow my wealth AMP Capital's Chief Economist, Shane Oliver, examines Australia’s response to COVID-19 Read more
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