History and studies indicate that when people invest for the longer term and remain invested without making any periodical withdrawals, they are more likely to earn money and positive returns. There are a number of tools and strategies investors can use to maximise their investment potential while keeping their allocation to risk in check. Discipline plays an important role to the overall effectiveness of the investment strategy.
Markets oscillate. Markets fluctuate. More often than not, the swings are small in size. But there might be bouts when the volatility and market movements are difficult to ignore, and it could be tempting to make financial decisions in reaction to changes to investment portfolios. More often than not, investors who base their investment decisions on emotions often make rookie mistakes and end up buying when the market is high and selling when prices are low. Needless to say, these types of investors will find it harder to maximise the benefits of investing.
So what can an investor do to avoid falling in the trap and succumb to these mistakes? What strategies can one adopt to help reduce the risks associated with investing, and, more importantly, potentially earn more consistent returns over time?
Cost averaging
One of the most disciplined type of investment strategy is known as ‘cost averaging’, which seeks to smoothen out the effects of market fluctuations in an investment portfolio. Over the longer term, this is proven to be beneficial in achieving superior market returns as a result of the averaging effect on the purchase cost.
Within this approach, an investor will be apportioning an X amount of Euros towards a particular asset class (such as equities, bonds or funds) within his/her investment portfolio, on a regular basis, say for example every 15th day of the month. The consistency in investing is an important caveat for this strategy to work out, since investors will be purchasing more shares when prices are low and fewer shares when prices are high. Over time, the average cost of investment purchased will usually be lower than the average price of those shares. And it is for the fact that this strategy is systematic that it aids investors avoid in making emotional investment decisions.
Asset allocation
In a number of publications of mine, I have opined the importance of an adequately allocated portfolio as far as asset allocation is concerned. Appropriate asset allocation refers to the way an investor assigns allocations (weightings) within an investment portfolio in order to meet a specific investment objective. This undoubtedly, in isolation, is the single most important factor in the success of an investment portfolio.
Take for example, that investor whose goal is to pursue growth, and that investor is willing to take on sufficient investment risk commensurate with what is required to reach that goal, s/he may decide to place as much as 75% of his/her assets in equities and just 25% in fixed income instruments. It is of paramount importance that an investor knows a priori how the asset classes within a portfolio will be divided so as to ensure that the investments are aligned with the investment timeframe and the possible risks and rewards of each asset class.
Diversification is also key to achieving an adequately balanced portfolio as far as specific risks are concerned (such as issuer, currency, country, sector, amongst others) are concerned. Asset allocation and portfolio diversification hence go hand in hand. Portfolio diversification can then be terms as the process of selecting a variety of investments as well as instruments within each asset class to help reduce overall portfolio risk. Diversification across asset classes may also help lessen the impact of major market swings on an investor’s portfolio.
Disclaimer: This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.