INSIGHTS

TWO BASIC RULES = INVESTING SUCCESS?

Mark Lister, 9 August 2016

It’s quite easy to make money in shares. In fact, as long as you follow two basic rules, history would suggest you’re virtually guaranteed to.

All you have to do is firstly be well-diversified (own lots of different shares), and secondly measure your success against an appropriate timeframe, ideally 10 years or more. Not exactly rocket science.

The diversification bit is easy. Any decent adviser you work with will drum that into you on day one (and probably every day thereafter), and if you’re a small investor there’s always an index fund to provide instant diversification.

Keeping your eye on the long game is definitely more difficult, especially when you’re in the thick of some short-term market turmoil. But it’s non-negotiable for any good investor, and if a decade ahead sounds too far away to think about, then shares probably aren’t for you anyway.

The thing with financial markets is that the further ahead in the future you look, the more predictable things become. That’s the opposite of just about everything else in life, but a lot of things about markets aren’t very logical.

Data on US shares back to 1871 is readily available. The average annual return since then has been 8.9 per cent, and shares were up in 74 per cent of those 144 years.

Not bad at all, but the short-term variation has been huge. The best year saw a 51 per cent gain, and during the worst shares fell 37 per cent (that was 2008, which just edged out 1931).

But things are a lot less scary if we look at them in five-year groups. The proportion of positive returns for shares jumps to 91 per cent, the best per annum performance falls to 27 per cent and the worst to -10 per cent.

Move to 10-year blocks, and investing looks fairly simple. Shares were higher 99 per cent of the time, the best annual return was 19 per cent over the period, and the worst just a 1.1 per cent loss (again, the 10 years leading up to 2008).

The annual average return was almost exactly the same as the original 8.9 per cent too. All that changed was things became more consistent, and less volatile.

The results are similar for New Zealand. Looking at returns going back to 1967, there’s never been a 10-year period where the market has fallen.

So there you have it. If you’re well-diversified and you maintain a sensible investment time horizon, history suggests you’re almost guaranteed to turn a profit.

Markets are impossible to predict over days, weeks, months or even years. But the likely returns you will get and the volatility you will have to suffer become much easier to see as we look further ahead.

A good share portfolio will just about always do well over the long-term, which is what most of us are investing for. The hard bit is keeping your cool and remembering that while the short-term is going haywire.

This article was originally published in the New Zealand Herald on 9 August 2016.