Editor’s note: The following article contains information only. It is not intended as personal or general advice. Your Money recommends seeking professional financial advice specific to your personal circumstances.
In times of increased volatility, negative investor sentiment and a softer domestic property market, it is even more important for investors to stick to fundamentally sound principles when formulating and adhering to an investment strategy.
I have solidified the past 16 years of experience of advising clients into eight simple principles or rules.
These rules are rooted in sound logic. And there is a huge body of observable evidence (including in my book Investopoly) that demonstrate these rules produce long-term value.
1. Play the long game
The best question you can ask yourself is “what you can invest in today that will maximise your wealth in 10 years’ time?”
This forces you to take a long-term view.
Delayed gratification is your best friend because short-term profit does not create long-term value for anyone.
The best quality financial decisions are almost always long-term ones. You will ultimately be an unsuccessful investor if you think short-term, be impatient or greedy.
2. Set important goals
It is impossible to formulate even a basic financial plan without an idea of what you what to achieve. Specifically you should ask yourself how much income you need and by when.
Not starting with a goal (no matter how simple) is like jumping into your car and driving around without a destination.
Also, having a goal gives you a context to make financial decisions.
That is, you can ask yourself ‘if I do X or Y, which one will get me closer to my goal?’
In the absence of a clear goal, it is very difficult to decide which option (X or Y) is best for you.
3. Spend less than you earn and invest the difference
Building wealth is simple. Spend less than you earn and invest the difference regularly.
It’s a simple strategy but it works. If you spend all your income, or worse, more than your income, it is unlikely that you will ever become financially independent.
Good cash flow management is just about knowing where your money goes. You cannot manage what you do not measure. So, you must start to measure your expenditure and there are lots of great apps and tools that make that super-easy.
4. Grow your asset base first and concentrate on income second
Everyone knows that you need to build a house in a certain order.
First you lay the foundations so that they have enough strength to support the walls. Once the walls are erected you can then put the roof on.
You can’t build a house in an ad hoc manner e.g. build a little bit of the foundations, then some of the roof, then walls and back to the foundations.
The same is true for investing.
You must invest in asset classes in the right order to efficiently build wealth. You need to do it in two steps.
Firstly, you must build your net worth (assets), so you must invest in assets that provide most of their total returns in capital growth, not income.
Second, once you have a strong asset base, you must invest to generate passive income.
Investing for income first is a highly inefficient strategy because you lose too much money via taxes.
5. Strategically allocate your assets
What should you invest in? Property, shares, bonds, commercial property, cash or something completely different?
The answer to this question is to develop an asset allocation that is well diversified, balances out your portfolio’s volatility (risk) and combines assets with negative correlations.
In simple terms, if you have a finger in every pie, you should make money no matter what the markets do.
Asset allocation is an investors most important decision because you cannot control the markets and its performance, but you can control where your money is invested.
This is one of the mast important roles of any decent financial adviser.
6. Invest in shares using a low-cost, passive method
Avoid stock-picking (direct shares) and expensive actively managed funds. The clear majority of active fund managers fail to beat the market over the loan run.
Trying to pick a winning stock (or managed fund) is akin to finding a needle in a haystack says Burton Malkiel, a world- renowned economist and author.
Malkiel suggests that instead of trying to find a needle in a haystack, just invest in the haystack (i.e. an index fund).
7. Only invest in property that is deemed ‘investment-grade’
Three attributes must be present for a property to meet this classification.
First, more than 50 per cent of the property’s value must be land. Second, the property must in a location where land supply is scarce and architectural style and property type must also be scarce. Third, the property must have a strong track record of historic capital growth.
A property must possess all three characteristics and probably less than 5 per cent of property in Australia does.
8. Protect your investment strategy from expected and unexpected risks
The most common risks that can compromise an investment strategy’s success include loss of income due to accident or illness, job loss, higher interest rates, getting sued and relationship breakdowns.
You must take all steps to mitigate these risks.
Sticking to these rules will almost guarantee success because they prevent the common mistakes made by investors.