One moment you’re cruising, the next you’re buffeted by headwinds. Investing is never plain sailing, but smart investors learn how to maximise returns, no matter what the weather.
Investing is a lifelong journey of discovery. Like any journey, there are bound to be hazards and detours along the way; but don’t let that put you off. Successful investors know that a market setback isn’t the end of the road. In fact, it could be the opportunity of a lifetime.
That’s because all markets generally move in cycles, so this year’s best performing asset class could easily be next year’s wooden spooner.
Take shares for example. In 2009 Australian shares returned almost 40 per cent; two years later returns were down by 40 per cent.1 Yet shares produced an average return of 9 per cent a year over the 20 years to 2014, the highest of any asset class.
Clearly, you’ve got to be in it to win it. But that doesn’t mean closing your eyes and hoping that time will heal all wounds.
In order to share in the good times and minimise your risk in a market downturn you need patience and discipline. What’s more, you need a plan.
Here are some tips on how you can help protect your financial future:
Yes, the message about diversification is repetitive but that’s because it is so important. Spread your money across the four asset classes - shares, property, cash and bonds – to protect yourself against a market correction in a single asset class.
Aim to diversify your investments within each asset class
This is to avoid what is known as concentration risk. For example, don’t put all your money in one or two investment properties. You can’t unload a property quickly in a stagnant or falling market, or sell a room at a time if you need some cash. You also run the risk of being exposed to a single geographic location and property type. If the government decides to build a new freeway past your front door, you stand to lose money. Listed Real Estate Investment Trusts (REITs) offer greater flexibility and diversification. They can be bought and sold like shares and invest in a range of property types and locations.
If prices are booming in one asset class and falling in others, it’s possible that your portfolio may become unbalanced. By selling some of your best performers and buying temporarily unloved but quality assets at bargain prices you may achieve the Holy Grail of investing. That is, you effectively buy low and sell high.
Keep your head
One of the biggest mistakes nervous investors make is to sell out of a market after a downturn only to follow the herd back in after prices have already bolted. Not only do they crystallise their losses but they pay top dollar to get back into the market. By learning how to read market cycles and changing investor sentiment you can profit from other people’s mistakes. As investment guru Warren Buffett said: be fearful when others are greedy and greedy when others are fearful.
Choose investments that can be sold quickly and easily
This is what is known as liquidity. Shares in quality, blue chip companies are generally easier to sell than small, speculative stocks if there is a rush for the exits. Not only do quality companies have more shares on issue but if they operate a valuable business their share price is more likely to bounce back when the market recovers.
Have a cash buffer
You don’t want to be forced to sell assets when prices are low. Have a mix of short-dated and long-dated cash and fixed interest securities so you maintain enough cash to tide you over during a downturn.
By following these simple guidelines you are in a better position to strap yourself in for the investment trip of a lifetime, hopefully enjoying the ride while you’re at it!