What I’ve Learned from 30 Years of Investing — Part 2

Oil up. Dollar up. Dow Jones up. All positive indicators that our market is in for a good day.

The only fly in the market’s ointment could be the release of any adverse trade and lending data from the Chinese economic update due later today.

The unexpected meeting between Fed Chair Yellen, US President Obama and US Vice-President Biden on Monday sent the rumour mill into overdrive.

Obama and Yellen rarely meet. Their last official business meeting was November 2014. The three have never met to discuss the economy before.

What was so important?

Were they discussing martial law in the event of a banking collapse? Is the US economy in far worse condition than what we are being told? Are the global risks that Yellen identified in a recent speech greater and more imminent than previously thought?

According to media reports, the meeting had a ‘crisis-like’ feeling about it.

The Credit Suisse Fear Barometer went into overdrive, hitting an all-time high.

The meeting would have been an opportune time to review the failed strategies of the past seven years. QE doesn’t work…unless of course your intent was to make the rich richer. Denying savers a decent rate of return is criminal. Negative interest rates are clearly a dumb and desperate move. Doctoring the economic data has fooled some people but not all of them.

Unfortunately, I don’t think the discussion went along these lines.

Perhaps the rise of Donald Trump due to the fall of America’s middle class prompted Obama and Biden to make an enquiry on what is really happening in the economy.

Obviously matters like debt and deficit are not of any great interest to the Obama administration (or any administration for that matter). So perhaps they wanted to know if it was still ok to keep racking up expenses (nudging close to US$1 trillion per annum) on the government credit card.

We’ll never know the true nature of these talks. Which leads me to the second part of the series on what I’ve learned from 30 years of investing.

In life there are factors you can and cannot control.

You have no control over investment markets. What you do have control over is the discipline you apply to the allocation of your capital to those markets.

Do not chase returns

This is a follow on from patience. If interest rates are low, the temptation is to leave the safety of the bank and chase an extra few percent. Invariably (unless you sell early) the cost for chasing the higher return comes with loss of capital — this loss is usually far greater than the few percent you earned.

Investments can be like icebergs — it’s what you don’t see that usually causes the most damage.

This is what I mean about understanding investments. The simple rule of thumb is this: if the return offered or implied is above bank term deposit rate then you are potentially placing some or all of your capital at risk. If you cannot quantify this risk, DO NOT invest.

During the boom times so many opaque investment products — offering various rates of return — come to market. While different in some ways, they all have a common denominator — the underlying investments are ‘geared up’ to enhance yield and due to the complex investment structure higher management fees are charged.

Simple and transparent investments may not set the adrenalin racing during your waking hours, but you will sleep a whole lot better.

Always take profits

You never go broke taking a profit. The greed in our DNA often blinds our objectivity. The desire to squeeze the last drop out of a winning investment can be very overpowering. Ignore the voice of greed in your head and be happy to leave some for the next person.

Besides greed, the other reason people don’t take profits is because they’re worried about paying too much tax. This is just plain dumb, dumb, dumb. Got the picture? Paying tax is a cost of successful investing. Live with it. Under Capital Gains Tax (provided you’ve held the investment for 12 months) the taxman will extract a maximum of 22.5% of your gain. You keep 77.5% of your gain.

On the other hand, the market does not give you a formula on what it will extract — it can take away all your profits and some or all of your capital. The market can be far more brutal than the taxman.

Taking profits locks in your gains and adds to your capital base. Even if you take out your original capital and let the profits ride, you will have at least protected your situation.

Taking profits is even more critical if you are investing with borrowed money. In late October 2007, my weekly newspaper column The Big Picture warned investors with margin loans to be prudent and sell enough shares to pay down their debt. Sadly, this advice was ignored and the capital destruction from the losses on margin loans in 2008/09 are well documented.

Busts always, always follow booms

Since Tulip Mania became folklore we know booms always bust. Yet when the animal spirits capture society’s emotions this logic is abandoned in the chase for the almighty dollar. Night follows day and booms always bust. When the heat is on in the market — get out and stay out. The market may get even hotter and you may experience sellers remorse — get over it. The hotter the market becomes the more violent the snap back to reality will be.

Look at the All Ords index and the near vertical move up from 2003 to 2007. The GFC ‘snap back’ took the market down to levels first seen in 2001. So even if you sold in 2006 — and watched the market continue to soar — you would have ended up well in front. This ties in with ‘never be afraid to take a profit’.

Source: Yahoo Finance

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The post-GFC Fed induced recovery has recouped some of the 2008/09 losses the Australian market experienced.

However in the US, the Dow and S&P 500 indices have both been pushed to record highs due to the Fed’s (highly successful) asset reflation efforts. This boom will bust and our market will be caught in the downdraft.

Never in the course of history has there been a boom without a bust. Human nature dictates that these two go hand in glove.

Transparency of investments

Only invest in something you understand. There are so many ‘iceberg’ investments out there. You think you see the risk, but most investors have no idea what lurks beneath the surface.

The rule of thumb is: If you don’t understand it, don’t do it.

Simple, easy to understand investments — cash, term deposits, an index fund tracking the ASX 200, gold bullion, etc. — may be boring but what you see is what you get. There are no exorbitant management fees, no fancy promises and more importantly, no nasty surprises.

Sure an ASX 200 index fund can fall heavily in a bear market — but at least that is a risk you know. An individual share could fall much further due to internal gearing levels, poor management or other corporate shenanigans. Unless you are on the inside, you are not fully apprised of these matters.

Worst still are the option trading programs — the ones that paint the picture of you lying next to the pool while you earn a living. In my circle of contacts I know a few serious traders and they do not lie around the pool. They spend an inordinate amount of time tracking elaborate momentum models, researching and executing trades. Every day is a day of learning to these guys. So delving into a specialised area you have no experience or knowledge in is sheer madness and a guaranteed way to lose money.

KISS is the overarching style in my model portfolio. If you feel tempted to pursue a ‘once in a lifetime’ opportunity, invest only what you can afford to lose.

The final part in the series will be published next week.

Vern Gowdie,
Money Morning

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

Money Morning Australia