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The Nine Most Important Things About Long-term Investing

1) THERE IS ALWAYS A CYCLE
Investment markets constantly go through cyclical phases. Some are short term. Some are longer, such as the secular swings seen over 10 to 20 year periods in shares. Some get stuck in certain phases for long periods. Debate is endless about what drives cycles, but they continue. All eventually contain the seeds of their own reversal.

2) THE CROWD GETS IT WRONG AT EXTREMES
Cycles in markets get magnified by bouts of investor irrationality that take them well away from fundamentally justified levels. This is rooted in investor psychology and flows from a range of behavioural biases investors suffer from. 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. The problem is that when everyone is bullish and has bought into an asset in euphoria there is no one left to buy but lots of people who can sell on bad news. So, the point of maximum opportunity is when the crowd is pessimistic, and the point of maximum risk is when the crowd is euphoric.

3) WHAT YOU PAY FOR AN INVESTMENT MATTERS A LOT
The cheaper you buy an asset the higher its prospective return. Guides to this are price to earnings ratios for share markets and yields, i.e. the ratio of dividends, rents or interest payments to the value of the asset (the higher the better). It follows that yesterday’s winners are often tomorrow’s losers because they became overvalued and over loved and vice versa. While this seems obvious, the reality is that 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. The key point is that the more you pay for an asset the lower its potential return and vice versa.

4) GETTING MARKETS RIGHT IS NOT AS EASY AS YOU THINK
In hindsight it all looks easy, it always looks obvious that a particular boom would go bust when it did. Looking forward no-one has a crystal ball. Usually the grander the forecast – calls for “great booms” or “great crashes ahead” – the greater the need for scepticism. Such calls invariably get the timing wrong (in which case you lose before it comes right) or are dead wrong. Market prognosticators suffer from the same psychological biases as everyone else. If getting markets right were easy, then the prognosticators would be mega rich and would have stopped doing it long ago. The problem for ordinary investors is that it’s not getting easier as the world is getting noisier. The flow of information and opinion has turned from a trickle to a flood and the prognosticators have got louder.

5) INVESTMENT MARKETS DON’T LEARN
A key lesson from the history of investment markets is that they don’t learn. The same mistakes are repeated over and over as markets lurch from one extreme to another. This is even though after each bust cycle many say it will never happen again and the regulators move in to try and make sure it doesn’t. Sure, the details change but the pattern doesn’t.

6) COMPOUND INTEREST IS LIKE MAGIC!
In Australia, the average annual return on shares (11.8% pa) is just double that on bonds (5.9% pa)* over the last 119 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 at a higher long-term return is huge over long periods of time. The same applies to other growth-related assets. *Source AMP Capital

7) IT PAYS TO BE OPTIMISTIC
The well-known advocate of value investing, Benjamin Graham observed that “To be an investor you must be a believer in a better tomorrow.” If you don’t believe the bank will look after your deposits, that most borrowers will pay their debts, that most companies will grow their profits and that properties will earn rents, then you should not invest. Since 1900 the US share market has had a positive return in roughly seven years out of ten. So, getting too hung up worrying about the next two or three years in 10 that the market will fall risks missing out on the seven years out of 10 when it rises.

8) KISS (KEEP IT SIMPLE, STUPID)
Investing should be simple. People have a knack for overcomplicating it and it’s getting worse. When we overcomplicate investments we can’t see the wood for the trees. You spend too much time on second-order issues like this share versus that share, so you end up ignoring the key driver of your portfolio’s performance – which is its high-level asset allocation across shares, bonds, property, etc. So, it’s best to keep it simple, don’t fret the small stuff and don’t invest in products you don’t understand.

9) YOU NEED TO KNOW YOURSELF TO SUCCEED AT INVESTING
We all suffer from the psychological weaknesses referred to earlier. Smart investors are aware of them and seek to manage them. One way to do this is to take a long-term approach to investing. If you want to take a day to day role in managing your investments, you need to recognise that this will require a lot of effort to get right and will need a rigorous process. 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 that the best approach is to seek advice.

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