Diversification (spreading our investments around) is valid – but is it right?

Investment Perspective – January 2015

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Too many eggs in one basket can be a problem – especially if we have limited resources and ineffective method.

Diversification though can be suitable for cautious investors but less suitable for conservative investors who know that they must invest for growth.

We know that diversification reduces pricing volatility.  It can also slow down returns.  Even a 1.00% per annum lower return makes a significant difference long term.

Then there is “inflation”

If over 25 years the cost of living increased by 50% and your investment by comparison increased only 10% you would not be happy about that would you?

Actually, the correct question might be “would you even know?”

For most New Zealanders, investing is about term deposits and the interest rate they get on the day.  Those who are a bit more advanced might deduct tax but only a few will then deduct the cost of living or inflation (measured at times by the CPI). 

Also, after a period of low inflation (such as the last five years for example) people start believing that inflation is not really a problem. 

I mention it now because inevitably after a period of prolonged low inflation, the cost of goods and services tend to rise.

This brings us back to the best place to invest for those that know little or nothing about money, which inevitably is either to pay off debt or indeed deposit funds in the bank.

It is only the “best investment” of course from the point of view of “easy” and “safe”.  Minimal time and effort required. 

Unfortunately though the perceived safety can be challenged when we look at an increasing cost of goods and services against a taxable return by way of interest. 

Also, whilst highly unusual but in severe circumstances such as the global financial crisis it is possible to see banking default.  Not many New Zealanders have suffered bank default but there is nothing to say that it will not happen at some point in the future, particularly as the New Zealand government reviews its potential position in the event of another global financial crisis in the future.

Many New Zealanders are saying “the government will just bail us out”.  The government is currently saying “that may not be possible”.  What bank in New Zealand is Government guaranteed?

And then there’s managed funds

KiwiSaver is becoming the best-known example of managed funds here in New Zealand and yet there are a variety of different types. 

For example there are UK listed trusts and there are New Zealand based unit trusts.  The main difference being taxation and levels of cost. 

Then there are exchange-traded-funds (commonly called ETF’s).  Basically they are pooled investment with no management cost and only a small administration fee.  They are considered useful because many fund managers seem unable to beat the actual market in which they invest.  This argument suggests that investing passively in growth markets might be the best way.

For those who want to make real money longer term – invest direct

This just means rather than using a fund manager, invest directly into shares and property or your own business. 

By the way, shares are really just a form of business.  The main difference being they are large publicly traded businesses with greater scale and transparency than those small closely held private enterprises owned by mums and dads around New Zealand and the world.  Shares are just the smaller bits of the overall business – large enough to list on a stock exchange.

The combination of direct shares, property and ones own business I promote as The Sustainable Wealth Model and for some is the winning combination.  Perhaps a more advanced approach but at the same time fundamental, reliable.

Making money is about mentality – not intelligence

Without doubt there are intelligent people who are rich.  However, not all intelligent economists, accountants and other intellectuals are well off financially.

Whilst intelligence at some level is a prerequisite, the real key lies elsewhere.

I am not suggesting that successful investors do not have some degree of intelligence.  My experience suggests (over three decades now) that the most successful investors are those with an appropriate mentality. 

Without doubt, unless you are one in a million, you will need some help with learning what works (method), to gather the market intelligence, do the research and carry out proper investment analysis.  You might also benefit from some “mindset help” when things become difficult or events challenge conditioned “beliefs” (e.g. falling prices can mean value emerging).

Whilst nothing is for certain in this world, some things make a lot more sense than others.

For example, investing in productive assets that grow is a good idea long term.  Also, (when it comes to investing in direct shares) once we understand that good businesses are those that consistently use capital well then we have an advantage.

Once we know that the compounding effect of productive assets works best when the profits are redeployed back into the business we have a significant advantage – Warren Buffett’s Berkshire Hathaway is proof of that – without a doubt.   By the way, I am not talking about the price movement of Berkshire Hathaway shares.  That is because price movement is nothing more than an indicator of popularity, particularly in the short term.  It tends to have little to do with the underlying economics of the business.

Sometimes it is not about bright shiny new objects or new things but rather, understanding what we already know …

Happy holidays and all the best for 2015.