- Invest for the long term
In order to maximise the power of compound interest, it is important to develop a long-term plan that suits the investor’s wealth, age, risk criterion and tolerance for volatility, and then stick to it. The cyclical fluctuations of markets can show up the disadvantages of taking a short-term approach. For example, in the immediate aftermath of the GFC investors who switched all their funds to cash missed the market rally.
- Take advantage of compound interest
The power of compound interest is shown by the fact that $1 invested in Australian shares in 1900 would have grown to nearly $400,000 today, giving a 12% annual average return. The longer you’re in the market, the better the results, provided you’re comfortable with the level of risk this entails.
Take maximum advantage by ensuring an adequate exposure to growth assets, contribute to your investments early and often and avoid being put off by volatility in investment cycles.
- Diversify investments
An old adage but a good one is not to put all your eggs into one basket. It is important to spread the investment mix across a range of asset classes that best suit your long-term investment strategy and goals rather than opting for the investment flavour of the month such as a “hot” commodity or sector.
- Ignore the hype
Short-term trends can prove misleading for investors as shown following the GFC when many investors reallocated from higher growth assets such as shares to lower risk but weaker performing assets such as cash and term deposits. Once a strategy has been decided, it is important to maintain it and not overreact to short-term fluctuations or noise.
- Cash flow is king
Focus on investments offering sustainable cash flow rather than relying on promises of high returns and low risk. Billionaire US investor Warren Buffett famously saved millions by refusing to invest in overvalued technology stocks during the dot-com boom. As Buffett says “never invest in a business you can’t understand” and if it looks too good to be true, it probably is.
- Asset allocation is the new black
A key learning from the GFC is that asset allocation is now the key driver of investment returns rather than active security selection or choice of manager. Choose a fund that manages a long-term strategy but takes advantage of active asset allocation to make adjustments that maximise shorter-term market opportunities.
By adopting these strategies and taking advantage of asset allocation, it is possible to maximise performance even in an uncertain world of volatile returns.
