Thursday 12 April 2012
Many investing books focus on “get rich quick” strategies. These tend to be around picking specific shares or times to enter or exit the market or investing in unusual types of assets(buy to let housing, ostrich farms, etc).
Smarter Investing: Simpler Decisions for Better Results
is different; it is a champion of the passive investing school. This argues individuals have only a few choices to make, firstly which broad types of asset to invest in and which fees, taxes and charges to pay.
is different; it is a champion of the passive investing school. This argues individuals have only a few choices to make, firstly which broad types of asset to invest in and which fees, taxes and charges to pay.
Many ”gurus” claim you can time the market, moving into shares when prices are low and selling when they are high. However research shows where the gains from shares are generally concentrated in a few days spread randomly over decades. If you miss one of these big winning days it might take years to catch up.
The other frequent claim is that you can stock pick specific shares and beat the market. However it is not possible for the average investor to beat than the market, this is because market is the sum of all participants and for every winner there must be a loser.
The professional investment fund industry promise market beating returns. In order to do this they incur costs in research, buying and selling and administration that eat into returns. However the average performance of funds before costs will on average be the market average. This makes professionally managed investment funds a poor choice for individual to invest in. Such funds tend to advertise based on past performance, even though they state that past performance is no guarantee of future success.
The alternative is passive funds which aim to track a recognized broad index of shares and so have far lower costs. They aim to grow with the market and not to beat it. The market has a strong rate of return over many decades from capital growth and share dividends. Unlike professional managed funds there is no need to pay for star investment managers and so costs are lower and more of the returns from the stock exchange are passed to the investor and not their advisors.
Individuals can also reduce the risk of their portfolio by investing in other assets. The main example is government bonds which pay a fixed rate of interest. The choice of how much of other assets and their relative riskiness is a key investment decision an individual should make. The amount invested in different asset types depends on an individual’s investment timescale and their psychological profile when faced with risks.
The final piece of the puzzle is rebalancing where an individual periodically examines their investment and adjust them back to the desired level. This involves buying and selling assets to return to a target split. So an individual may want to a half their money in bonds and half in shares. If shares rise faster than bonds over a period of time they will have to sell some shares to buy bonds. This is counterintuitive as it seems to involve selling when assets are rising, and buying when they are falling. But it helps to keep risk levels stable and locks in some gains when shares rise, and buys when prices are low.
This book recommends an individual
1. Sets investment goals and timeframes
2. Determines how much they need to invest and the risk they are prepared to bear
3. Sticks largely to asset classes that are well understood and where markets for index funds operate – bonds and shares
4. Rebalances that risk periodically.
5. Relentless fights against taxes, fees and charges that eat into returns
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