There is no ‘right’ way to invest in shares, but there are some methods and strategies that tend to work better than others.
Investing is like town planning, in that it has to look forward. Try as we may with tea leaves, weather maps and computers, humans struggle with guessing what the future holds. In the field of investing the best we can do is look backwards and see what has worked in the past and hope a similar pattern occurs in the future.
Which leads nicely into our first golden rule. Something that definitely doesn’t work is to expect recent returns to repeat themselves. In January 2001 global shares had delivered an annual return of 21% over the previous three years.
If you had invested $10,000 into global shares in 1998 it would have been worth $17,715 by 2001. If you had instead chosen New Zealand shares over the same three years your $10,000 would have grown to a paltry $10,895 as our market only returned 2.9% a year over these three years.This situation reversed over the next three years. New Zealand shares returned 10.5% a year while global shares fell by 16% a year. If the investor had continued to stick with their New Zealand stocks it would have grown to $14,700 by 2004, while the global stocks would have shrunk to $10,500.
The lesson is clear, don’t ‘straight line’ current trends. Investment markets move in cycles, not straight lines.
Another lesson from the above example is that you should have your money spread across various markets. Nobody predicted that global markets would be as strong as they were over the 1990’s, nor that they would collapse as dramatically as they did over the 2000’s. New Zealand‘s reversal of fortune was also a surprise. Which will do best, New Zealand stocks or global stocks, over the next three or five years? Nobody knows, so own both.
Another lesson worth heeding is the value of asset allocation – spreading your money around various investments like property, shares and bonds. While many dismiss diversification as ‘dull’, it is something that people with serious money take very seriously.
And last but not least, prefer shares that provide a decent dividend stream, and have the potential to grow this dividend. Investing in shares is ultimately about growth and growing your capital but, in our view, capital growth follows income growth. You are therefore best to look for companies that provide a solid dividend and have the potential to growth this dividend. Capital growth will follow.
Also, the market’s constant ups and downs become a great deal more tolerable if the shares you own are paying you a dividend twice a year.
According to Elroy Dimson, Paul Marsh and Mike Staunton of London Business School, if you had invested $1 in the U.S. sharemarket in 1900 and spent all your dividends, your portfolio would have grown to $198 by 2000. But if you had reinvested all your dividends, your stock portfolio would have been worth $16,797. We agree with U.S investment commentator Jason Zweig who says, "far from being an afterthought, dividends are the greatest force in share investing."
