“People are buying anything these days”, a friend commented to me recently. I couldn’t disagree with them. There are unproven companies with no profits worth billions, ‘memes’ on social media driving share prices and a frenzy surrounding cryptocurrencies. Speculators in these things are often taking huge risks, generally focused on the short term or otherwise backing ‘moon shoots’ with slim chances of success. It’s perhaps a sign of the times, with so much extra money created by central banks sloshing around the world looking for a home.
Hopefully, your clients know that buying an obscure cryptocurrency or a ‘call option’ that will either soar or (much more likely) be worth next to nothing is only for those with an appetite for self-destruction – or else it’s a wild gamble on the side that they are happy to take and hopefully prepared to lose. But if someone else is doing it – and apparently making money – it can be a difficult message to get across.
Firstly, we need to categorise this sort of activity firmly in the ‘speculation’ or ‘gambling’ camp and remind people that even the best speculators run out of road if they keep going. Just as the house always wins eventually at the casino. The time-honoured investment principles of diversification and the compounding of modest, positive returns over long periods tend to ultimately win out.
The maths doesn’t lend itself to a flowing conversation, though, so it may be best to provide an example of the compounding ‘snowball’ in a table or chart. People tend to think in a linear manner but when they see the effect of returns on top of returns the penny drops. To take an example, if you earn a return of 7% a year on £10,000 this is what happens to your investment over time:
- 1 year - £10,700
- 5 years - £14,025
- 10 years - £19,671
- 20 years - £38,697
- 30 years - £76,122
It is also worth pointing out that the highest returns, particularly short-term ones, are ephemeral, difficult to find and probably involve a fair amount of luck, so it’s very difficult to produce them consistently. Instead, aiming for pretty good returns, regularly and for a long period of time, can be hugely effective and have a much higher chance of success in terms of building long term wealth.
What sort of mentality does an investor need to grind out these sorts of returns year after year? Focus and consistency are the key attributes to my mind – and the sporting world offers a good analogy. The big-hitting cricketers that hit sixes into the crowd often draw the most admiration, but it’s often the more conservative players that tend to accumulate the really big scores. Alastair Cooks’s 294 runs against India in 2011 (a modern-era record for an Englishman) is a great example. His teammate and then captain Andrew Strauss recalled the key to the innings was: “Cook's ability to maintain concentration and play the same way throughout – he didn't really up the gears, he just kept batting in his usual non-fussy way." Cook wasn’t scintillating to watch. He didn’t take on difficult deliveries or go for many big shots, but he faced 545 balls in a calm, methodical manner and simply avoided getting out. Once you are out you can’t score any more runs, just as in investing if you lose all or most of your investment you can’t recover.
A conservative investing style won’t capture much excitement or admiration in the short term, but it’s more often successful. Something like 70-80% of spread betters on financial markets lose money – because their bets are necessarily short term – but longer-term investing turns the odds in your favour. There is no guarantee that history will repeat itself, and we can’t rely on past performance, but various studies on the US market have shown that the chance of losing money on the broad stock market over a ten-year period is around 10% and based on history it falls away to zero for a multi-decade period. The biggest thing you can do to increase your chances of investment success is to extend your time horizon.
Lots of people like to take a small or calculated gamble for some fun, especially wealthy clients with capacity for loss. That’s fine so long as the bulk of the portfolio is consistently jumping one-foot hurdles rather than attempting ten-footers and falling over. The hard bit of course is consistently securing these decent, if unspectacular, returns. The stock market might average a return of about 7% a year over the very long term, but it tends to lurch around and jolt people off who don’t feel comfortable experiencing the full extent of the ups and downs.
That’s why tempering those movements with a diverse portfolio can make sense. Spreading investments across different geographies and sectors of the economy will help to a degree, and a variety of assets more so. High-quality bonds can balance the risk of shares by benefiting from a slower than expected economy. Other assets such as infrastructure and property can diversify further and add a useful income stream to returns, plus other forms of portfolio protection can be employed for more cautious investors.
Take a look at our diversified portfolios tuned to a given return objective and level of risk for some ideas.
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