The dawning of a new year invariably prompts financial soul-searching, most of us resolve to learn from the mistakes of past years and finally get our investing house in order.
Acting on the following resolutions can help you to do just that.
Don’t average down
The more the market declines,
Warren Buffett
said during October’s sell-off, the more he likes to buy.
That makes sense. Investors should cheer market declines and buy stocks when they go on sale.
Sometimes, however, investors continue to add to a losing position in order to lower their breakeven point.
For example, a stock may have declined from €20 to €10. The investor may be panicking, but decides to buy more, reasoning he will be able to break even if the stock gets back to €15.
However, an individual stock can always drop lower – by continuing to average down, the individual position becomes outsized, and losses can get completely out of hand.
This isn’t value investing, it’s gambling motivated by loss aversion, and it’s very dangerous. (Seán Quinn’s mammoth Anglo-Irish Bank position comes to mind. In 2012, he said it was “never our intention to own 25 per cent of the bank, but as it got cheaper, we just seemed to buy more and we got sucked in”).
Instead of averaging down, consider scaling into a position over time, all the time ensuring you do not end up with a larger position than originally intended.
Be wary of stock-picking
Stock-picking isn’t easy. After all, the vast majority of fund managers and hedge funds underperform the market.
Think you can do better? Consider this: since 1980, according to a recent JPMorgan study, 40 per cent of US stocks have suffered large, permanent declines (defined as a drop of 70 per cent or more that was not recovered). Two-thirds of stocks have underperformed the index. The median stock returned 54 per cent less than the index.
The reason the overall market did well is because of a handful of winners – some 7 per cent of stocks are extreme winners, driving the index. The odds of picking such stocks in advance are tiny.
Unless you have a proven, tested approach, it may be better to take indexing guru John Bogle’s advice: don’t bother trying to find the needle in the haystack, just buy the haystack.
Save early
The importance of
early investing
cannot be overestimated.
Take a 25-year-old who invests €1,000 into a retirement account earning 8 per cent annually. Let’s say that aged 35, he stops adding money but leaves the lump sum untouched. Aged 65, his €10,000 investment will have swollen to €169,000.
In contrast, a 35-year-old who puts away €1,000 annually into the same account, and who continues to do so for the next 30 years, will end up with an account worth just €125,000. He has ended up with less, despite investing three times as much money.
Compound interest, in fact, accounts for much of Warren Buffett's fortune. Ben Carlson from the Wealth of Common Sense blog notes that Buffett was worth $3.8 billion in 1989, when he was aged 60. Since then, Buffett's annual percentage returns have been stellar, but well short of those recorded between 1965 and 1989. And yet, he is worth $63.3 billion today. Some 94 per cent of his wealth has been created since his 60th birthday, despite the reduction in his investing returns.
Expect
volatility If you realise market volatility is normal, you will be less spooked when it inevitably arrives.
Although US stocks have historically returned about 9.5 per cent annually, returns vary wildly from year to year. In two-thirds of the years since 1926, stocks either soared by at least 20 per cent or dived by more than 10 per cent. Market returns fell into the supposedly normal 0 to 10 per cent range on just 14 occasions over the last 85 years, or one year in six.
These figures are worth remembering the next time the market dives, or when indices swing wildly from one extreme to the other. The media will breathlessly talk of billions of euro being wiped out, of unprecedented volatility, of huge uncertainty in the marketplace. A narrative will be concocted to explain away every movement, as if what is happening is in some way abnormal or grave.
Market volatility is normal, and should be expected. If the thought of frequent market wobbles is too much for you, then steer clear of stocks.
Keep fees low
“There isn’t much about investing that any of us can say we are 100 per cent sure of,” said investing icon and bestselling author
Burton Malkiel
last month. “What I really am 100 per cent sure of: The lower the fee that I pay to the purveyor of an investment product, the more there is going to be for me.”
He’s right. Over 40 years, a €10,000 sum earning 8 per cent annually would compound to more than €434,000. However, annual management fees of 2 per cent would reduce it to about €205,000, meaning the fund has siphoned a large chunk of your return.
Bogle, who has championed low-cost index investing for decades, puts it well: “Do not allow the tyranny of compounding costs to overwhelm the magic of compounding returns.”
Eschew forecasts
The median Wall Street forecast for 2014 envisaged a 6.4 per cent rise for the S&P 500. The index has risen by nearly double that amount.
In 2013 the index soared by more than 30 per cent, which was more than double that forecasted by strategists.
Nor do analysts have any idea where earnings are headed. According to a 2010 McKinsey report, analysts typically forecast earnings growth of 10 to 12 per cent a year, almost double the 6 per cent growth achieved.
Economic forecasts are similar. A recent IMF study noted that 49 out of 77 countries were in recession in 2009, even though as late as September 2008, the consensus forecast was that none would fall into recession. The same study found that of 15 national recessions in 2012, none had been forecast a year earlier. The data for 1990s recessions is similar.
This inaccuracy can be found in all fields, whether it be politics, medicine, investment or some other arena. Quite simply, forecasting the future is extremely difficult.
Serious investors know this. They realise the prediction game is best viewed as entertainment, and laugh off the silly price targets set by analysts and second-rate tipsters.
The future, says renowned money manager Howard Marks, "should be viewed not as a fixed outcome that's destined to happen and capable of being predicted, but as a range of possibilities".
Or, as as economist Edgar Fiedler memorably put it, he who lives by the crystal ball soon learns to eat ground glass.
Miscellaneous
Don’t fall in love with your stocks – good investors are objective and unafraid to change their minds.
Don’t check your portfolio too often. Rebalancing once or twice a year is sufficient for long-term investors.
Diversify.
Ask for evidence. Much of what is said about stock markets is either wrong or irrelevant.
Be aware of your time-frame. If you’re trading in and out of stocks, detailed valuation analysis is of little or no relevance. If you’re a long-term investor, there’s no point in slavishly following market developments.
Think long term. Few master the short-term game.
Strive to be humble. The best investors know how little they know; the worst confuse brains with a bull market, and luck for skill.
