Investing in a rational way is not always easy.
I was reminded by a client’s recent questions of a time before I had studied financial planning and investment. How should I invest? What investments will make money? What about risk? Could I lose all my money? At the same time, I had someone wanting to sell me insurances. But how much did I really need and of what type? The financial world seemed to have many more questions than answers. It felt like a big black hole of unknowns where expensive missteps could easily take place.
Many years have passed since then. In the interim I have studied, advised, written articles and, importantly, I have lived life. From these I have learned. I wrote an article recently on the lessons I would teach my children. Start investing early, compounding is the magic ingredient. Be disciplined. Invest into growth assets such as shares and property but diversify. Make the most of KiwiSaver. Pay your mortgage off as quickly as you can. And sell big risks to an insurance company – severe illness or accident, and when you have a family, death.
Decisions around investment and insurances now have clear answers. Knowledge has led me to the ability to make rational decisions. And in the investment world to be rational is one of the safest paths you can take.
But what is rational? An investor feeling unsettled by the volatility of share markets in late 2018 and deciding to move to bank deposits until the world feels safer probably feels like they are being totally rational. But they would have then missed the strong uplift in January 2019. Timing markets is, as history tells us, very, very difficult and tends to cost money rather than make it.
And if that investor had been aged 40 with a 25 year plus time horizon then selling out of markets is even harder to argue as rational. So, rational is not always that easy. The ultimate investment test perhaps.
If I had to distill my most important learnings, they would be these:
1. Research and understand the investment traps we are prone to as humans.
2. Risk and return are related. The best investors understand that. They deliberately take on risk, but they have a plan to manage it. Diversification being one answer.
3. Asset allocation or investment mix. Having an allocation to growth investments such as property and shares is a key driver of returns. The allocation will decrease as I get older but I will have growth investments until the day I die.
If we implement each of these steps effectively, we will significantly increase our odds of success.
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Stephen McFarlane is an adviser with NZ Funds Private Wealth in Timaru. The opinions expressed in this column are his own. A copy of Stephen’s Disclosure Statements are available on request, free of charge.
First published in the Timaru Courier on 14 March 2019, as 'Investing in a rational way is not always easy.'
