Sorry to disappoint you, but I don’t believe there are any real secrets to investing. Every year, though, millions of people around the world buy books and CDs, attend webinars, seminars and the like on a quest to find them. In fact, the secrets to investing are quite simply a number of basic principles. These are:
1. Start early
I cannot begin to stress how important it is to start as soon as possible. If I had a dollar for every time someone said to me that they wished they’d begun saving earlier, I would have a large pile of money. Ideally, you should work towards saving a minimum of 10% of your income over your entire working life.
This is a principle of a world-famous book, The Richest Man in Babylon (1926), by George Clason. When you are younger, your savings could be part of your KiwiSaver contribution, or it could be saving for a home deposit. While starting early is very valuable, it is never too late; just decide to begin today, no matter how little you are starting with.
2. Pay yourself first
Most of us spend what we have. A good principle is to transfer part of what you earn directly into your savings or investment account as soon as you get paid. The saying “out of sight, out of mind” rings true. One could argue the reason most countries have a pension scheme is that the government figured out a long time ago that people can’t budget.
3. Time in the market, not timing
Think long-term. Far too many people try unsuccessfully to time the market. Don’t wait for the best time to invest. The common saying, which is very true, is “Time in the market, not timing”.
Markets can be quite unpredictable and volatile, particularly in the short term. Even the most experienced experts struggle to get their timing right. Typically, they work on a philosophy whereby as long as they get it right more times than they get it wrong, they are doing okay. This doesn’t give the average person much hope of being successful with their timing. Focus on the long term and don’t try to time the market.
4. Invest, don’t gamble
To invest in something, you usually have a reasonable idea, based on factual information, that you will get a return over a period of time. Gambling, or speculating, can be very risky and usually requires a lot more skill and expertise; it’s not for the average person. Let’s look at some examples:
- Investing – you buy a managed fund of New Zealand companies, run by a known investment company.
- Gambling – you buy shares in an oil company based in Argentina because you have heard there is an oil shortage and the prices of these shares are going to dramatically increase.
- Investing – you buy a rental property in a city or large town where you know there is good demand for rentals, you have worked out the cashflow and are prepared to hold it long term so it will increase in value.
- Gambling – you buy a property off the plans in a brand-new resort; the real estate agent tells you the area is going to boom, and your plan is to sell quickly and make a profit. (Note: the gain on this activity is taxable.)
Gambling or speculating can be okay, provided you accept the risks associated with it. There are often higher returns, but there is also more potential to lose money. Some people might put, say, 10% of their investing money into something that is more of a high-risk gamble. This would be an amount that they could afford to lose if the investment went pear-shaped.
5. Have an investment strategy that suits your risk appetite
Everyone has a different attitude to risk. In my experience, about 80% of people fall into the average-risk category.
They can accept a certain amount of risk and cope if their investments drop occasionally in value, as long as it’s not too great a drop for too long. They don’t necessarily expect huge returns; rather, they want a more consistently safe strategy. It’s important to know how you feel about risk. People become more accepting of risk when markets are strong, they invest aggressively and they forget about the potential downsides. When markets are weak, they suddenly find they are far more risk averse. If you can’t sleep at night when your shares drop even slightly in value, you shouldn’t invest in them. If you can’t deal with tenants trashing your property or not paying their rent (it’s bound to happen at some point), don’t buy an investment property. If you can sleep at night owing lots of money (investment debt), building an investment portfolio may suit you. If you are a conservative investor, stay away from private equity investments.
6. If it sounds too good to be true, it probably is.
Stay away from get-rich-quick schemes. The number of people who get caught up in scams is quite astonishing. I don’t know if you get as many emails as I do with pleas from a minor royal in a foreign land promising extraordinary amounts of money for help with getting their funds out of their country.
You may laugh, but many people have had their fingers burnt believing such promises. (After all, why would they spend so much time on their emails if it didn’t work?) Another common scam often targets high-earning professionals: you get a call from a “stockbroker”, based overseas, offering some fantastic share whose price is about to go through the roof, but for this “opportunity of a lifetime”, you must invest immediately before it’s too late. If it sounds too good to be true, it probably is.
7. Keep it simple
Keep your investment strategy as simple as possible. The more complex it is, the harder you will find it to understand and therefore manage. A key component of successfully building a savings or investment fund is to keep doing it consistently over a long period. If you find it takes too much time to manage your investments, you won’t do it. If you find it too hard to understand, you will also keep putting it off. Keep it simple and keep at it.
8. Be patient
It takes time. When talking to clients about building an investment portfolio, I encourage them to think at least 10 years ahead. Almost all investments have cycles. Typically, they go up, may go sideways for a while, and may go down before they eventually go up again. Over the long term, investments should go up in value. Ten years should smooth out the effects of market cycles.
9. Don’t overreact to short-term fluctuations
Research indicates that the people who invest for the long term have received higher returns than those who invest short term or try to time the market. This is simply because investors tend to buy when the market is high (when everyone is talking about a great investment) and sell when the market is low or not performing well (when everyone is talking about what a lousy investment it is). When an investment goes down in value, take a deep breath and ask yourself why you bought that investment in the first place. If that reason is still there, hold on to it and ride through what tends to be, in most cases, a short-term fluctuation.
It may even be a good idea to continue buying at “sale” prices.
10. Always reinvest the interest
Always, always, always reinvest any income you receive from your investments (unless, of course, you are in retirement and living off the interest). If you invest $10,000 and spend the income from that $10,000, your investment will always be $10,000. This is a problem because of inflation, which, over time, erodes the value of your $10,000. This means that in, say, 10 years’ time, your $10,000 will buy much less than it does today. You want to ensure that, over time, the growth of your investment outpaces inflation.
11. Tax is not the main reason to invest
Please don’t invest in something just because you feel that you are paying too much tax and you want to get some back. To get a tax rebate from Inland Revenue, you must first have a loss. And much to some people’s amazement, you get back only part of what you’ve lost. For example, if you made a loss of $6000 and your personal tax rate was 33%, you will get only $2000 back. Note: this doesn’t apply to managed funds in respect of your personal tax return, and because of recent tax changes, any loss made from a property investment can be offset only against future profits.
Losing a dollar to get a third back is a lousy reason for making an investment. Depending on the circumstances, however, it can be a bonus. When accountants tell people to buy an investment property, or business owners to buy new cars, because they are paying too much tax, it drives me nuts. Isn’t it about making money? Surely you would be happy to have a huge tax bill, as it would mean you’ve made lots of money.
12. Keep your emotion out of your investing
- I liked the look of the property so I thought it would be a good investment.
- I really like the chief executive of XYZ Ltd or like their products, so I bought their shares.
- I’ll just wait until the shares get back up to $5 again before I sell them. (What happens if it takes 25 years?)
- My neighbour who I was chatting to over the fence said they were a good buy.
- Everyone else seems to be buying them, so maybe I should.
Do these sound familiar? Do you think they are solid reasons to buy an investment or are they based on emotion? Emotion plays a big part in the way people invest. Successful investors learn to invest on the numbers and facts, not emotions.
13. Work with an expert or become one yourself
If you can start putting 10% of your income into a long-term savings plan from a very early age, you will develop a reasonable sum of money for retirement. If you leave it much later, you will likely need some help and will need to save a larger amount.
Far too many people take advice from their friends and family about investments, which I believe can be a case of the blind leading the blind. In New Zealand today, about half of all adults have either negative net worth or, by the time they cash up, almost no net worth. Throw in the fact that for most New Zealanders, government superannuation is their only source of income in retirement, and you must wonder if friends and family give good advice. Ask yourself if the person you seek advice from is qualified to give that advice. If the answer is no, you need to talk to or learn to become an expert or seek professional advice.
14. Get advice
I would expect most financially successful people would be getting some form of professional advice and the more successful they are, the more advice they probably get. There is a lesson in that.
Extract from Good with Money: 8 Simple Steps to Ditch Your Debts, Grow Your Savings and Live Your Best Life, by Lisa Dudson (Upstart Press, RRP $39.99).
