Investing For Growth: The Three Main Principles (Part 1)

05.06.12

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An investor?s portfolio should be built around their specific objectives. While these vary considerably between investors they often fall into two broad categories ? investment to ge

An investor?s portfolio should be built around their specific objectives. While these vary considerably between investors they often fall into two broad categories ? investment to generate an income and investment for growth for wealth preservation or to accumulate money to meet a future goal.

Unfortunately too many investors lose sight of their long-term goals or get concerned about short term events affecting their investments. As a result many fail to achieve their objectives or end up losing money. Day-to-day financial events can be a big distraction for most individual investors, but reacting to them in uncertain times may cause you even more difficulty down the road.

It is natural to be concerned when markets are volatile and falling, but if you have a suitably long-term plan for your investments and adequate cash reserves to cover your short-term needs, then you should try not to react to bad news, even if it can be hard to ignore.

If you are investing for growth, then I normally recommend three main principles.

1) Time in the market

2) Spread the risk

3) Regular reviews

Time in the market ? not timing the market

Investors who remain invested over the longer term often achieve better results than those who attempt to time the market.

Most investors should therefore plan to be invested for the longer term. This is a minimum of ten years, though longer is preferable for many more. Many investors who attempt to ?time the market? often end up disappointed. In some cases they end up significantly worse off.

There are two key reasons why people time the market. Some try to be clever about when they buy and sell to maximise gains. Their aim is to predict when a share will be at its lowest point and then when it is at its highest point. There is no formula for successfully timing or guessing market movements. You would need to predict the future (and many events that affect markets cannot be predicted) and you would need to be right twice.

Many other investors make emotional investment decisions. They are influenced by short-term market movements and react to them, when instead they should focus on the longer-term trend and how this fits in with their own investment objectives.

Investor sentiment actually lags market movements so those who react to sentiment often enter and exit the market at the wrong time.

Investors can go though a roller coaster of emotions, starting with optimism, moving on to excitement and then euphoria as markets rise higher and higher, before changing to anxiety as markets fall off their peak and slipping through anxiety and fear to despondency as markets fall, before improving again through hope and relief back to optimism.

Many investors enter the market or invest more money at the ?euphoria? point ? but this is actually the riskiest point in a market cycle. Likewise the point of maximum financial opportunity is the time when most investors are despondent and so fewest people are investing at this point.

For example, if you compare movements in the FTSE 100 index with historic net investment flows (investment purchases minus investment sales by retail clients) into equity funds by UK investors since the early 90s, we can see that investment flows significantly increase when markets peak, and conversely decrease during market dips.

However, often the best returns from equity markets come in periods just after a downturn. Markets are very sensitive to economic events and can rebound quickly after good news. Those investors who sold out after markets had fallen usually miss out on the best of the upside and this can have a significant effect on their overall investment performance. Those with capital available to invest who were waiting for markets to improve usually miss out on the opportunity to profit from much, if not all, of the sharp increase in performance.

Often a few very good days account for a large part of the total returns over a market cycle. If you miss these days you could end up with considerably less profit, or even make a loss when you could have made a gain.

As an example, let?s look at a hypothetical investment in the S&P UK Mid-Cap companies sector index. Investors who invested ?10,000 on 31st December 2001 and left it untouched up to 30th December 2011 earned a ?5,183 profit. Those who missed just the five best days over the 10 year period only received a profit of ?191. Those who missed the 10, 20 and 30 best days saw significant losses – ?6,569 in the cast of 30 days.

In Part 2 I look at spreading the risk and the importance of reviewing your portfolio. Click here to read Part 2.

By Bill Blevins, Blevins Franks Financial Correspondent

16th May 2012

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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