Investing: 4 questions to realise better investment returns
Investing – simple! Buy low-Sell high-Repeat! So why do so few investors manage to get this straightforward formula to work on a recurring basis?
The basis of successful investing is mindset: specifically asking questions, 4 in fact.
What is it that I really believe about a stock’s (and the underlying company’s prospects)?
What do I know that other don’t?
What ‘noise’ to do I need to filter to confirm my answers to questions 1 and 2?
Where can I get support?
It should be remembered that gross equity returns (on average 7% per annum) remain the single best means to invest for one’s wealth in the future. There are few alternatives available that beat that asset class. Yet, Investing is beset by an increasingly hostile and challenging setting.
Approximately two-thirds of share trading in is dominated by high frequency algorithm trades and ETFs. The IoT means that speed and volatility have increased reducing reaction times to seconds and accentuating trends. The theoretical rare ‘black swan’ is rather common-place. With active investing, even professional investors/advisors can find it difficult to beat the market on a consistent basis. Many individuals investing on their own tend to fall foul and don’t realise their desired returns. Millenials are most exposed as they: lack the experience of boom years, depth of asset pool, have a high loss aversion and as well as overreliance on web-based knowledge and services.
Behavioural finance research reveals that our own heuristic biases can be an investor’s Achilles’ heel. Each one of us thinks that she/he is an excellent investor, the reality or results tell a different story. The major reason is market timing. Bear markets can be as rewarding as Bull ones. Most individual investors do not get the timing right, largely because of lack of a disciplined process, and greed and fear.
In this context a measured questioning approach can allow one to enjoy above average returns over the long period – even taking into account inflation and fees (be it related to platforms, funds or professional services).
The key 4 questions to better investing
1. What is it that I really believe about a share’s (and underlying company’s) prospects?
The investment markets have become dominated by shorthand metrics that actually don’t aid one’s understanding. For example: Price to Earnings (P/E) ratios are an article faith to analysts, but it is sloppy shorthand - an accounting perspective.
It is cash flow and a company’s ability to generate it that is the basis of viability and the prospects for growth. These aspects drive share price dynamics. If one were to use a shorthand then Earnings over Price (E2P) is better.
Not to know and not to understand is akin to gambling – the odds are rarely in one’s favour.
2. What do I know that other don’t?
In short: ‘what is my insight’? If the information is in the Press, on the news or the web that information is already baked-into the share price. Thus the canny, questioning investor will have information the rest of the market does not have or understand something that the market doesn’t understand. This is not ‘insider information’. It is about developing an insight; for that product/service-trend-company-sector.
Peter Lynch, the famed fund manager at Vanguard based his whole investing success on what he observed; then seeing if it made sense to his analysis of companies. Lynch has always maintained : "In the stock market, the most important organ is the stomach. It's not the brain."
Thus develop a perspective that identifies an opportunity or “event” that will affect a company and its share price: sending it up or down. Both movements are of value to a diligent investor.
But how to cut through the cacophony of the market and its participants and hawkers?
3. What noise does one need to filter to confirm one’s answers to questions 1 and 2?
Behavioural finance is a fascinating field of science. We humans have biases that are hard to beat and often toxic to investors. The Nobel laureate, Danial Kahneman, has described them well.
We need to see these biases and heuristic behaviours for what they are and avoid them. Pride; Excessive confidence; Inability to take profit or cut a loss; Confirmation bias; Pattern vision; Hindsight bias; Order preference and Loss aversion. These aspects can accentuate timing errors. These innate aspects tend to lay low many a well-intentioned, once wealthy , investor.
A seasoned financial advisor, can act as a sounding board, helping to compensate for one’s heuristic biases. But picking relevant metrics and being objective is an essential first step. Develop a bench mark and metrics to measure it. Do these metrics fit: your objectives and related risk/return profile, amount you are willing to invest, cash needs, regular pay-out requirements and preferences? Diversify! Know when to enter and exit.
Caveat emptor! If it is too good to be true, then that is probably correct.
4. How good is your game?
Performance varies: reflecting how one plays risk and reward over time with what amounts. It boils down to: passive or active. Regardless of approach, a seasoned financial advisor can be invaluable, but selection is as much about IQ as it is about EQ; fees need to seen relative to value-add, alternatives time-service-quality provided.
One can just take a passive tack to investing; and be happy with a fund’s performance - most often with returns at the average of the market, sometimes less.
For those wishing to be active investors there are a set of requirements to consider. Does one have the time and resources to establish oneself as a day/week trader? Returns can be above any average (in the teens and sometimes higher); but time consuming and may not be sustainable. Most individuals don’t and also lack the disciplines, time and resources to do so. They become disappointed.
To the active investor, a financial adviser, where one has a true relationship, is good context to pose the three questions discussed above. One can discuss, be inspired and challenge as well as obtain cost/effective transaction services is. Different strategies can be developed: straight equities, a laddered approach of equites and options; as well as other asset classes. For the passive investor, a financial advisor can help steer one through the daunting jungle of choice of financial products that are on offer: funds and UCITS and other products for savings, retirement or ISA accounts. The power of compounding is rewarding.
There is a wealth of information and experience available: online; in print and from commentators, fellow investors; friends & family as well as financial professionals. Leverage them in a structured manner to invest; using you quiver of questions to best protect your interest and prospects for market beating returns.
Feel free to contact us at Gate to discuss our 4 questions.