A rewarding investment experience is built upon an understanding of how markets work and how your actions, and reactions, can affect your outcomes. A strong foundation gives you the confidence to stick with your plan throughout the ups and downs, so you can live better and feel better—not just years from now, but today.
Whether you’ve been investing for decades or are just getting started, at some point you’ll likely ask yourself some fundamental questions. The 10 listed here highlight key principles, backed by data and common sense, that can help improve your odds of investment success.
If mutual fund managers could consistently identify winning or losing assets, you would expect their returns to show it. But they don’t.
Historically, only about one in five US-based funds survives and outperforms over 20 years. That’s based on our research of 2,860 equity mutual funds that existed in 2004. Two decades later, more than half of these funds had folded, often due to poor performance. And only 18% of equity funds were able to survive and outperform their benchmarks over this period. Your chances are even worse for fixed income funds,
where only 15% survived and outperformed. Are those odds you’d bet your savings on?
The market is an effective information-processing machine. Millions of people buy and sell stocks and bonds every day, and the real-time information they bring helps set prices. This means trying to outperform by finding securities that are priced too high or too low is difficult for anyone, even professional money managers.
Some investors select funds based on past returns, but relatively few winners keep winning. Research shows that most mutual funds ranked in the top-performing 25% based on five-year returns did not remain in the top 25% in the next five years. Only around one in five of the top-performing equity funds stayed on top, and only about a third in fixed income did.
In other words, past performance offers little insight into a fund’s future returns.
Rather than basing an investment strategy on trying to pick the winners and avoid the losers, one approach is to simply buy and hold a slice of a market index through an index fund, gaining ownership of many different stocks. Over the past century, that approach would have rewarded you with a return that far outpaced inflation—and it would have helped you avoid the stress of trying to predict the future.
But investing in index funds has its limitations, as an index fund is only trying to match the returns of an index, not beat them.
Yes, because index funds’ focus on matching—rather than beating—benchmarks can be unnecessarily rigid. For instance, index funds have to buy and sell stocks when the benchmark they track changes its holdings, which can happen as infrequently as once a year. Like shopping for roses on Valentine’s Day, that leads to a lot of people buying the same thing at the same time, which drives up prices.
Constraints like this mean that when you invest in index funds, you may be leaving money on the table.
A more effective investment approach for fund managers is to be flexible, buying and selling stocks throughout the year based on information backed by financial science on what can improve expected returns.
Academic research into decades of stock returns has identified long-term drivers of outperformance. Smaller companies, those with lower prices, and those that are more profitable have had higher returns, on average. By investing systematically in the areas with higher expected returns, you can aim to beat the market.
THE DRIVERS OF OUTPERFORMANCE
Investment opportunities exist all around the world, but the randomness of global stock returns makes it difficult to predict which markets will outperform from one year to the next. For example, Austria was the best-performing developed market in 2017 but the worst the next year (and, in 2021, the best again). Holding a globally diversified portfolio that targets higher expected returns better positions you to capture higher returns wherever they appear. And a strong year in one country can help offset a weaker one elsewhere.
Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Diversification neither assures a profit nor guarantees against loss in a declining market.
Investment opportunities exist all around the world, but the randomness of global stock returns makes it difficult to predict which markets will outperform from one year to the next. For example, Austria was the best-performing developed market in 2017 but the worst the next year (and, in 2021, the best again). Holding a globally diversified portfolio that targets higher expected returns better positions you to capture higher returns wherever they appear. And a strong year in one country can help offset a weaker one elsewhere.
Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
Diversification neither assures a profit nor guarantees against loss in a declining market.
Every day, stocks are priced to deliver a positive expected return. That means now is always a good time to invest. This goes against the “buy low and sell high” mantra that leaves some people trying to find just the right moment to invest. Frequent reports of all-time market highs may keep you from buying, thinking surely what goes up must come down, so I better wait. But research shows that buying shares at all-time records has, on average, produced similar returns to stocks bought following a sharp decline. That means trying to time when to get into and out of markets is unlikely to lead to better results.
We rely on professionals in so many areas of our lives. When you get sick, you can scan the internet searching for a remedy—or you can go to a doctor who has years of training on the best, safest way to help. Trusting an expert with your financial health is no different.
A financial advisor can provide expertise and guidance. They can help you focus on taking constructive actions that add long-term value, not impulsive ones you may later regret. And they can help you build a portfolio based on financial science that is expected to outperform the market.
Consider whether you’d benefit from help with any of the below:
With a deep understanding of our client’s objectives, we provide tailored solutions to assist clients in achieving their financial goals.
New Horizon Wealth PTY Ltd ACN 632 726 222 is a Corporate Authorised Representative of Lifespan Financial Planning Pty Ltd
AFSL No. 229892
ABN 23 065 921 735
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