Seven golden rules of investing'Our favourite holding period is forever.' Warren Buffett (American investor and philanthropist, 1930-)
An investor who puts money aside over the long term for the proverbial rainy day is far more likely to achieve his or her goals than someone looking to ‘play the market’ in search of a quick profit.
The longer you invest, the bigger the potential effect of ‘compound’ performance on the original value of your investment, so long as you reinvest your profits. Compounding the process whereby interest on your money is added to the original investment and then, in turn, earns interest. Over time, it can make a huge difference.
| Inflation-Adjusted Return from the FTSE All-Share Index (31.12.85 to 31.10.11) | |
| Compounded | 5.9% Per Anum |
| Simple (Interest paid on the principal sum only) | 2.1% Per Anum |
Past performance is not a guide to future performance.
Source: Datastream and M&G Statistics 31.12.85-31.10.11.
Whatever investment approach you choose, it is important not to ‘overpay’ for the sustainability of a company’s returns or its prospects for future growth. In our opinion, following a bottom-up strategy (where individual companies are judged on their own merit and not in relation to sectors or economic conditions) with a disciplined approach based on company fundamentals to identify the right stocks for your portfolio, is not a bad way to invest. It can simply be a case of waiting patiently for the right opportunity. We believe that putting your money into a good stock at a reasonable price can often be better than investing in a reasonable stock at a good price.
Inflation, taxation and charges (such as dealing, switching and annual management fees) are three of the factors that can affect the real rate of return on your investment. There are certain options available that can reduce costs, including the use of tax-efficient wrappers, namely Individual Savings Accounts (ISAs), pension plans and employment ‘save as you earn’ schemes. There are also inflation-proofed instruments, such as index-linked bonds (bonds where the payment of income on the principal sum is related to a specific price index – often the Retail Price Index, National Savings Investments or commercial property holdings, where rents can often be linked to the rate of inflation.
Holding a portfolio of investments with a low level of correlation can help to diversify the perils associated with investing in individual assets and markets, as well as less visible hazards like inflation risk (the possibility that the value of assets will be adversely affected by an increase in the rate of inflation) and counterparty risk (when investment transactions are entered into directly with an eligible person or institution (a counterparty), there is a risk that the counterparty will not meet its obligations or become insolvent which could lead to losses). Shares, bonds, property and cash react differently in varying conditions and opting for more than one asset class can help to ensure your investments won’t all rise or fall in value at the same time.
Geographical exposure and long-term investing are other ways of spreading risk. Investing in vehicles such as OEICs (Open-Ended Investment Companies) can also remove a lot of the difficulty associated with managing a broad portfolio. And, above all, investors should aim for a level of risk they are comfortable with, and that reflects their objectives.
'The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.' Sir John Templeton (investor and mutual fund pioneer, 1912 – 2008)
As we saw to great effect in 2008, following the collapse of US investment bank Lehman Brothers, and at times this year, unexpected or negative views can have a significant impact on stockmarket performance. While it is impossible to predict when or how the sovereign crisis in Europe will end, the current ‘economic storm’ has created some phenomenal bargains for investors willing to retain their exposure to risk. Indeed, many highly cash-generative, defensive businesses capable of creating value in a range of market conditions have been hit by the same negative sentiment that has driven down the price of stocks more sensitive to economic conditions and those that are poorer quality.
Inspired by the mutual funds pioneered in the US, M&G launched the first unit trust in the UK, the First British Fixed Trust, in 1931. It allowed private investors to take a stake in a fixed portfolio of 24 companies, spreading their risk across a greater number of assets than they could practically manage themselves.
'An investment in knowledge pays the best interest.' Benjamin Franklin (one of the Founding Fathers of the United States of America, 1706 – 1790)
While a well constructed portfolio can produce a healthy return for investors, the converse is also true. It is easy to incur permanent losses by putting money into an asset that behaves in an unexpected way. Investors should always set aside some time to try and understand what it is they want to hold.
'The four most dangerous words in investing are "This time it’s different".' Sir John Templeton
History is no indication of how an investment might act in the future and investors should always try to weigh the potential risks associated with a particular investment alongside the prospective rewards.
Please note that past performance is not a guide to future performance. Prices and the level of income produced by an investment may fluctuate and investors may not get back their original investment. The value of overseas investments may be affected by currency exchange rates. The views expressed in this article should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of any investment, speak to a financial adviser.
Download a PDF of this article here (300 KB)
Return to document archive
