Investing is all about focusing on the problem you’re trying to solve.
For example, suppose you want to build your wealth. The first point is to decide over what period of time.
Most people think two to three years is a short investment timeframe, five to seven years is a medium time horizon and anything beyond seven years is long term. I think these timeframes are way too short.
The reality? Under 10 years is short term. 10 to 20 is medium term. And over 20 is long term.
Nearly everyone who is still working or not long retired is a long-term investor in relation to their retirement savings. As we can’t predict how long we’ll live, and with increasing average life expectancies, it makes good practical sense to assume you’ll live a long time and hence be a long-term investor.
Long-term outlook means focus on income
If you’re investing for the long term, the change in the value of an investment becomes significantly less important and the income that an asset pays takes on much greater significance.
Why? Because the value of your investment from day to day fluctuates and you can’t control at what price you can sell an asset for. If your investment pays you income, which regularly increases over time, then logically you would expect someone would be prepared to pay you a higher price for that asset. While you might have a reasonable expectation of increasing income, you can’t guarantee you’ll get a higher price for your asset when you want to sell it.
This view is very much counter intuitive to most media commentary you hear, or reporting about investment returns, which focuses on share prices and the change in value of super fund investments and only looks at investment income as a passing thought.
Ignore the market noise
With almost 30 years indoctrination by the so-called market boffins in my head, it took me a while to realise that this fascination with daily or regular market movements and short-term returns isn’t helpful or useful.
Let me give you a very simple example involving Australian shares. In June 2009, the ASX200 All Ordinaries Index was 3955. Then, in June 2010, it was 4302. Twelve months later it was 4608; and in June 2012, it was worth 4095.
Over this three-year period, an investment in this market index hadn’t gone anywhere, which would prompt most investors to wonder if they should be looking at other opportunities. I’ve lost count of the number of times investors have expressed various levels of displeasure because the share price of an asset they own hasn’t changed too much “recently”.
Over our three-year investment period, many of these ASX200 All Ords companies continued to pay dividends to their shareholders. From one year to the next, in each year the income paid by these companies increased faster than the official inflation rate. Clearly, this hasn’t been reflected in the value of these companies’ shares.
The best strategy
So here we come to the basic strategy part of long-term investing:
- Pre-retirees invest for retirement in 1 to 50 years – the job of your retirement assets is to deliver you the income you need to live on in retirement. Invest by concentrating on the income your assets earn and reinvest that income into the same or similar income-producing assets to earn more income. The income you earn increases because of two factors – you’ve invested in assets that pay an increasing income each year and you’re investing the income you earn each year, which in turn generates more income. Follow this process until your investments pay your retirement income target that will increase with inflation. A good example of this strategy is the ASX 200 All Ordinaries Accumulation Index, which assumes that you reinvest your dividends in companies listed in that index.
In October 2007, the ASX 200 All Ords Accumulation Index was worth 42,624. And in October 2013, was valued at 44,873. In other words, by reinvesting dividends, you’ve recovered all your losses.
By contrast, in October 2007, the ASX 200 All Ords Index was worth 6754 and today is worth about 5300. That is, it’s still 27% below its high point.
Bottom line – the market value of your investments is irrelevant.
- Retirees – your investments now need to pay the income you no longer work to earn. That income needs to increase with inflation.
The risks
The problems with my simple and effective approach are three-fold:
- You need to ignore most of the daily chatter about market movements.
- You also need healthy doses of time, patience and discipline. When the markets drop violently, how will you emotionally react? Not going to pieces is vitally important.
- And finally, my approach is boring – dividends are only paid twice a year.
The added benefit
It allows me to get on with the rest of my life, which is really important to me.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Charlie Aitken: Super profits from super companies –Platinum, Macquarie [1]
- Ben Griffiths: An excellent exposure to aged care for your SMSF – Ingenia [2]
- Roger Montgomery: Is the party over for Telstra? [3]
- Penny Pryor: Short n Sweet – Drillsearch, Tatts and Tabcorp [4]
- Penny Pryor: Buy, Sell, Hold – what the brokers say [5]
- Questions of the week: Too late for JB Hi-Fi and NEXTDC? [6]