Five Lessons That Stand The Test Of Time
Like anything in life, investment markets go through phases. What’s fashionable one year can easily become passé the next. In fact, it often does.
For investments to truly stand the test of time, it pays to ignore the fads and focus on the things that are really important. That’s what makes some investment lessons simply timeless.
1. Do not try to time the market
Assessing the markets for the best time to invest is easier said than done. Intuition tells us that the best time to buy is when prices are down, and the best time to sell is when prices are up. However, trying to pick the top and the bottom of the market is extremely difficult and it increases the risk of being out of the market when it rallies.
Successful long-term investing isn’t about chasing the hottest performance. It’s about taking a long-term view and staying the course. While this doesn’t provide protection from market downturns, it does ensure investors benefit during times of market growth.
2. Diversification – the best protection against risk
History has shown that no single asset class outperforms year after year. Spreading a portfolio across a range of investments helps create a smoother and more consistent return and is one of the best ways to reduce risk.
While portfolio diversification often starts with investing across different asset classes, it also includes holding a spread of investments within an asset class across a range of companies, industries and even countries; and also investing with a combination of fund managers, for example, blending active with index managers.
3. Use dollar cost averaging
The discipline of investing money at regular intervals allows investors to capture the best and worst of market movements, plus everything in between.
While this strategy can be effective across many different market conditions, possibly the real value of dollar cost averaging is that the structure of such a disciplined investment program helps overcome the behavioural bias that often turns investors into market timers.
4. Rebalance annually
When establishing the initial asset class weightings for a portfolio, alignment with an investor’s risk and return profile is front of mind. And while better returns from faster growing assets are always welcome, this can often mean asset weightings have deviated from the original target mix.
Rebalancing a portfolio, or adjusting investments to match the target mix, ensures the level of risk in a portfolio is suited to an investor’s goals and objectives leaving them better positioned to ride out more volatile periods.
5. Costs matter
One part of successful investing is to keep the costs of investing low. All else being equal, investments with consistently low management fees and transaction costs can mean a head start in achieving competitive returns. Management fees create a drag on returns that can make it more difficult for a fund manager to add value. High fund turnover can lower a fund’s tax efficiency and also drive up transaction costs.
The chart below illustrates the significant impact costs can have on portfolio returns. It compares the Vanguard Australian Shares Index Fund to other wholesale Australian equities funds. Over the past 15 years, for every $100,000 invested in the Vanguard fund, investors could have saved $25,340 in fees simply by choosing the low-cost option.
Ultimately, lower fees mean more investment returns are passed on to investors, which positions them for greater long-term financial success.
* Vanguard research based on Morningstar and S&P data as at 30 June 2012. Vanguard pays a subscription fee for this data. Calculation assumes both Vanguard fund and fund with the industry average fee earn the annual historical return of the S&P/ASX 300 Index over 15 years commencing 30 April 1997. Returns are calculated net of management fee and assume all distributions are reinvested with no capital withdrawals and take no account of entry and exit fees and taxes. The industry average fee is calculated by Vanguard using Morningstar Direct data and definition of “wholesale fund” and is the average fee for wholesale Australian equities funds minus Vanguard’s fund for the period 30 April 1997 to 30 April 2012. The fee used for Vanguard’s fund is 0.34% p.a. The calculation assumes all other things are equal. The results would be different if an alternative index was chosen or if the survey of managers considered different or more funds. Past performance is not an indication of future performance.
Both the above article and chart has been reprinted with the permission of Vanguard Investments Australia Limited.
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