When share markets and other growth-related assets enter periods of intense volatility, people tend to lose sight of the basic reason they invest their money in them in the first place: to take advantage of the power of compounding returns.
This is a fundamental rule for investing, no matter what the prevailing conditions, and in general it means you have to be in the market, not out, if you want to your investments to reach their potential.
For as long as we continue to live in interesting times, here are eight other rules to bear in mind and keep you focussed on those compounding returns:
Invest for the long term
Historically, one of the most reliable way to generate wealth from investing is to hold positions for extended periods of time, absorbing pull backs and building on long-term market growth. Over the past 20-years, for Australian shares the All Ordinaries Accumulation Index has delivered annualised returns of 7.4%1 p.a. (before franking credits) despite three global contractions (the dot-com bubble, the 08-09 Financial Crisis and the current coronavirus pandemic).
Don’t get thrown off by the cycle
All asset classes generally go through good and bad cyclical phases. Some cycles could be considered as short term, such as the occasional correction. Medium-term business cycles could take place over three-to-five years. Longer cycles could see secular swings over 10-to-20 years in equity markets. There has been even the longer bull market in bonds which has occurred over 35 years since the early 1980s. It’s important to try and avoid being thrown off well thought-out long-term investment strategies by cyclical swings in markets. Of course, cyclical events can also create opportunities.
Turn down the noise
It can be easy to get caught up in panic and drama. Try switching off the nightly news before the finance segment begins and watch some bad reality television instead.
Buy low and sell high
It seems simple, but too many people sell out of a position after a fall in the market. For all the above reasons, it’s usually an incredibly bad idea, and can simply serve to lock in your losses.
Beware the crowds
Shares tend to bottom out at the point of maximum bearishness. Look for the bargains when everyone else is running for the exits and be wary of being late to move on a market rally.
As the fallout from the COVID-19 crisis demonstrates, market turmoil falls unevenly across different stocks and sectors. It’s a lot easier to accept market risk if you can minimise sector and company-specific risk through diversification.
Keep it simple
Don’t overcomplicate matters - focus on investments that you understand, and which provide decent, sustainable cash flows.
Finally, it’s never a bad idea to seek advice. There’s a lot to be said for a second opinion, especially from someone who has been through downturns before.
1 As at 30 June 2020, Bloomberg, AMP Capital
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