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MarketWatch May 2017

10 Timeless Rules of Investing….

brian-o-reilly.jpg Brian O'Reilly
Head of Global Investment Strategy
Eoin Corcoran 43x48.jpg Eoin Corcoran
Head of Portfolio Construction

All of us have worked hard to build capital and are looking to preserve and grow the real value of our assets, but when it comes to investing that money we often fall foul of simple mistakes that impact our ability to invest wisely. When markets are rising it’s easy to get carried away, but the longer we move on from the last downturn the more we tend to forget the mistakes of the past. We think now is an opportune time to take a step back and return to first principles. In this cover story we have combined our knowledge of the markets here at Davy with that of financial planner Carl Richards, who spoke at our annual conference a few years ago, to compile a list that we consider to be the 10 most important rules of investing.




This article is from our latest edition of MarketWatch, an in-depth report focusing on the 10 Timless Rules of Investing.  



Timing the market is notoriously difficult, even for the most experienced investor. People often focus on trying to dodge the bad days but fail to realise that missing even a few of the best days can be equally damaging. The reality is the largest gains tend to occur during periods of extreme volatility and often follow large sell-offs. During these episodes inexperienced investors panic sell or just sit on the side lines. Figure 1 shows that if you invested €1 million in global equities at the end of 2001, today that sum of money would be worth close to €2 million. However, if you were out of the market for the 10 best days during that time period, you would have made much less - about a 9% return. It gets worse. If you had missed the best 30 days you would have lost 46% of your money and if you had missed the best 50 days you would have lost 69%. The key lesson is that to be a successful investor it's often better to take the rough with the smooth rather than trying to play the market in search of a quick profit.

Figure 1: Total return on €1 million invested in global equities since 2001

Figure 1

Source: Bloomberg​



Most of the financial industry is incentivised to get investors to do something. Many investment houses and brokerage firms profit when investors buy or sell shares. This leads to a lot of noise in the market and it is often difficult to detangle good information from bad. TV shows dedicated to investing amplify the noise. It is challenging to distinguish good financial ‘experts’ from bad, as they are often more concerned with self-promotion rather than providing good investment advice. As George Soros said, “if investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring.”



The longer you invest for, the better your chance of success. For example, in the 26 years from 1990 to 2016, the average investor will have had a turbulent journey - the dotcom bubble and global financial crisis were two of the worst bear markets ever recorded. Yet over that period the return in a back-test of our moderate growth multi-asset portfolio would have averaged 7.4% per annum. That may not sound that impressive but €1 million invested in 1990 at that rate of return, mainly through the power of compounding, would now be worth almost €7 million. This is often difficult to comprehend as we tend to focus on performance in each calendar year rather than taking a step back and focusing on the long term. The lesson is that the power of compounding tends to be the single biggest contributor to an investor’s long term success.

Figure 2: Returns on €1 million invested in a multi-asset portfolio since 1990

Point 3

Source: Davy​



It is easy to focus on what can go wrong in the world and extrapolate these geopolitical events into investment returns. Yet geopolitical shocks (outside of world wars) tend to exhibit little or no relationship to returns. Last year was a case in point. Brexit and Donald Trump’s election as the US President threatened to send financial markets into a tailspin, but it never happened. In fact, markets rallied strongly in the second half of 2016. Over the past 30 years there have been two gulf wars, countless global health scares - SARS, Zika, Ebola - tragic terrorist attacks in New York, London, Brussels and Paris but none have seriously impaired the upward trajectory of the market for any length of time.



Diversification is probably the most commonly quoted piece of investment advice. Yet unfortunately, time and time again people tend to over concentrate their investments in a specific stock or asset. In the lead up to the global financial crisis too many people were holding too much property and bank stocks, and often with an overexposure to their own country. As we now know, that strategy did not work well. The idea behind diversification is that it spreads out risk and therefore helps mitigate all kinds of developments, especially negative shocks. The reality is that no asset, stock, region, sector or currency will outperform all the time. Multi-asset funds, which divide their investments between different assets, such as stocks, bonds, cash, property and alternative investments, aim to reduce permanent loss of capital through diversification. This strategy was pioneered by university endowment funds including Yale and Harvard. These funds built well-diversified portfolios of uncorrelated assets - like equities and bonds - to diversify and reduce risk while still benefiting from good investment returns.


"Irrational exuberance" was a phrase championed by former Federal Reserve Chairman Alan Greenspan to explain investor’s behaviour in the mid-to-late 1990s. Although it took a number of years for the bubble to burst, the phrase epitomises the tendency of investors to get most bullish just before a collapse. Quite often it’s wise not to follow the crowd, particularly if the fundamentals do not add up. Remember, when the herd is running towards the cliff, the one running in the opposite direction seems crazy.



Instead of following the herd, investors should take their lead from the economic and business cycle. One of the few constants in investing is that all economies are cyclical – that is they expand and then contract. By focusing on the cycle, investors can determine the prospect for different assets and markets at the different stages, and importantly can avoid taking on excessive risk when the economy is showing signs of overheating just before a recession. This will go a long way to explain the ebb and flow of corporate profits which are inextricably linked to the health of the economy. “This time is different” is arguably the most dangerous phrase used in finance. It never is. Buying high and selling low is not a sensible investment strategy. Investing counter cyclically is.



Overpaying for investments is a common mistake. The most recent examples of this phenomenon were the housing bubble in the run up to the financial crisis and of course the tech bubble at the end of the 1990s. Centuries of financial market history is littered with episodes of investment folly like tulip mania in the 16th century, the South Sea Bubble in the 18th century and the stock market bubble in the 1920s. Getting carried away is part of human nature. Private investors often do not have access to the same range of data and information as institutional investors so they often get caught out on price. This is true across all assets including the income yield for property investments, equity valuation metrics like price-to-earnings or price-to-book value, or bond yields. Warren Buffett says “price is what you pay, value is what you get”. Always consider the intrinsic value of an investment before putting your hard earned capital at risk.



Emotion is dangerous when investing. Unfortunately, it is too easy to become emotionally attached to investments when they are increasing in value. We feel comfortable when we are invested and often actively look to add to winning positions. When there is positive momentum around a market it may seem that an individual stock will never go down and that we should hold more and more of it. The most successful investors take profits and rebalance their portfolio regularly. Our experience shows that failing to take profits can result in ‘risk drift’ in portfolios and can lead to investors being overexposed to a market correction.



A common failing of investors is investing in the rear view mirror, chasing performance by buying more of an asset, sector or stock that has performed the best in the most recent time period. A large body of evidence tells us that this leads to underperformance in the long term. Assets that attract the largest amount of inflows subsequently underperform. Investors must accept that no strategy, investment or approach will outperform in every market environment.

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Warning: Past performance is not a reliable guide to future performance. The value of investments and of any income derived from them may go down as well as up. You may not get back all of your original investment. Returns on investments may increase or decrease as a result of currency fluctuations.