How do you tell a good investment from a bad one?
Written by Adon Beddoes on August 29, 2018.
The short answer is one that gives you a return on investment but of course it’s impossible to predict in advance how an investment will perform. If it were possible, we would all be significantly wealthier than we are! Asset classes are notoriously volatile – while equities might be the highest performing asset class one year, they can easily be bottom of the pile the following year, the top spot usurped by commodities, property or bonds.
If this is the question that you are asking, perhaps it is time to change your approach to investment strategy and think in terms of the process rather than focusing on product. What does that mean? Well, let me give you an example.
Let’s say your financial adviser calls you to advise you to buy a particular equity because his research has revealed that it is undervalued and likely to rise. This might happen for any number of reasons such as a new product being launched or a merger announced. 21st Century Fox shares, for example, reached record highs this year as a bidding war broke out between Disney and Comcast to acquire the company.
In this case the financial adviser is selling a product but not a process. There is little assessment of this individual investment decision in a wider context. Actively managing a portfolio in response to this kind of market news could be a good investment but it needs far greater assessment than the mere fact that the stock is likely to rise in value. How do you decide what percentage of your hard-earned savings to allocate to this particular stock? How will you judge whether it is a good decision to buy Fox shares and how will you decide at what point to sell them? Trying to time the markets is notoriously difficult, even for those who spend their entire lives doing it. If and when you sell, what will you buy in place of the Fox equities? The average investor doesn’t have the time or the knowledge to make informed decisions about these kind of questions.
We all dream of finding that magic investment which will make us rich overnight – right now cryptocurrencies are attracting that kind of investor – but long term investment success is rarely achieved in that way. That’s why here at Infinity, we focus on the process rather than the product. If you have a process in place, even seemingly terrible investments, can produce a return.
To give an example, when the housing market collapsed during the sub-prime mortgage crisis most people wisely steered clear of investing in property with prices crashing. However, there were canny investors scooping up abandoned properties and foreclosures for a song and selling them on who will have made a great return. Their success came from looking at a process and having a very specific risk management strategy.
So what should your process be? Here at Infinity, we strongly believe that for most investors looking to maximise return on their investments within their parameters for risk, the following principles apply:
Favour regular, consistent savings over get-rich-quick strategies
Forget chasing the next stellar share in favour of a regular savings habit invested wisely to make the most of compounding. This strategy has a name - dollar-cost averaging – which makes it sound complicated but all it really means is regularly investing money regardless of market conditions or individual stock prices in order to reduce the impact of volatility.
Spend time in the markets, not timing the markets
Dollar-cost averaging is all about buying and holding over a long term investment horizon. It eliminates any need to consider whether you are investing at the top or bottom of the market and to determine when to buy or sell. It takes the emotion out of investing, which when your objective is as fundamental as saving for retirement, is usually a very good thing.
As I mentioned at the beginning, asset classes can be volatile which is why spreading your investments across different ones will be key to your success. If property is tanking, perhaps commodities are having a moment - the losses in one asset class are balanced out by the gains in another. As in many areas of life, balance is crucial. If that sounds complicated, don’t worry, if you choose the right funds, an investment manager will do the diversifying for you. Just make sure that you select a company with a proven track record and where decisions based on in-depth market research. A good financial adviser should be able to recommend one.
In summary, there is no such thing as a good or a bad investment per se. Stop asking that question and instead ask ‘what is my investment strategy?’ If you’d like some help putting a strategy to save for retirement, your childrens’ education or anything else in place, why not let me help you devise one? I can be contacted at firstname.lastname@example.org for a free, initial consultation. I would love to hear from you.