For all the talk of elaborate remedies, the essential advice in the coronavirus crisis has been to wash your hands regularly, avoid touching your face and practise social distancing. The essential toolkit for long-term investors is similarly minimalist.
Of course, financial media is full of jargon about investment, often relating to passing fads or marketing hype around individual stocks, sectors or countries. Think back to the buzz around Enron or the dotcoms or the “BRICs” or the “high conviction” portfolios.
In truth, the principles of long-term investment aren’t particularly sexy or idiosyncratic. In fact, they really come down to the financial equivalent of washing your hands. Here are seven key principles to keep in your investment toolkit:
Forget trying to outguess the market:
The prices of securities in global markets represent the combined views of millions of participants. All the public information about those companies is already reflected in prices. So, instead of trying to second-guess prices, why not accept the collective views as fair and work from there?
Build your portfolio around the long-term drivers of return:
Big picture, what drives returns is your relative exposure to equities versus bonds. Within equities, large cap stocks perform differently to small caps, while growth and value stocks vary. Within bonds, your returns can vary according to your exposure to term and credit.
Spread your risk:
Diversifying across thousands of different securities, as well as different sectors and countries improves the reliability of outcomes. By doing this, you reduce idiosyncratic risk in your portfolio and ensure a smoother ride. And by spreading your risk, you’re positioned to reap the gains wherever they might occur.
Don’t drive via the rear-view mirror:
Who and what led the market higher last year is no guide to what might happen this year. Chasing previous winners is a fool’s errand. The news is interesting, of course. But it’s not a reliable guide to what you should do next as an investor. (When in doubt, see rule 3).
It’s not all in the timing:
There’s a natural temptation among investors to try to time the market. What if I get out now and get back in when things settle down? What if I switch from value to growth or from bonds to stocks to ride the next wave? This rarely works out well. In fact, not even the professionals are much good at it.
Constantly churning your portfolio according to what you might think will be the next big thing is an expensive business. The only people who make any money out of it are the brokers. Anyway, fees and costs are something you actually can control. And by keeping them low, you’re adding to your own bottom line.
Be true to what you decided in your most clear-headed moment. If you get too greedy when markets are up, or too fearful when they are down, you risk buying high and selling low. As anxious as markets might make you feel, sticking to the plan designed for you and rebalancing at regular intervals is a far better course.
Of course, this is not a complete list. Your strategy will also be dictated by your age, your circumstances, your other assets, your goals and what you value most. That’s why your financial plan is best guided by an independent financial professional.
But these seven key principles are a good start for anyone. They recognise that markets are super competitive and hard to beat. They accommodate the long-term drivers of return and they allow for the fact that every part of the market has its season in the sun.
Finally, and most importantly, these rules recognise that we are only human. There will inevitably be times, particularly when markets are volatile, that you may be tempted to take a short-cut or to allow your emotions to take over the investment process.
But if you refer back to these seven rules as your touchstone, you’re more likely to get a good result.
If you’d like to look into these rules in more detail, we think you’ll like our series Back to Basics:
Part 1: Starting with evidence
Part 3: Protecting your wealth
Part 5: Maintaining discipline
Here are some other recent articles you may have missed:
Investors’ need for a narrative
An ‘average’ year is rarer than you may think
The smarter you try to be, the worse you do
People are infinitely different. So are investment solutions
Steer clear of investment fads