4 investment lessons from the masters

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There is a plethora of information about investing available to us. While it can be challenging to source the best and most reliable information, perhaps we should look to the masters of the trade.

In the wise words of physicist and mathematician Isaac Newton: “If I have seen further, it is only because I stand on the shoulders of giants.”

Here are four important lessons from renowned investors that may help set you on the best path for your investment journey.

Compounding

“The first rule of compounding: Never interrupt it unnecessarily.” –  Charlie Munger, vice chair Berkshire Hathaway

At a simple level, compounding is earning returns on both your original investment and on subsequent returns.

Basically, Munger is saying that if you leave the returns on your principal investment invested, your returns have the opportunity to compound over time.

A simple way to enact compounding (and not interrupt it) is to take advantage of a distribution reinvestment plan (DRP), which is available on all BetaShares funds.

The aim of a DRP is to make it easy to earn compounding returns. Under a DRP, your investment will generate returns from both your initial holding and the additional units received on each distribution payment date.

An ETF DRP allows you to automatically reinvest your distributions as additional units in the ETF. Not only is it an automated process, removing the need to manually buy units through a broker, but it is also generally commission free.

As a result, participating in a DRP can smooth out your cost price. For a given distribution amount, if the ETF unit price has fallen, you will be entitled to more units; if the price has risen, you will be entitled to fewer.

It is important to understand that electing to participate in a DRP will generally not affect your tax outcome for the financial year in which the distribution was declared as the amount of the distribution will generally form part of your taxable income.

If you participate in a DRP, be sure to keep a record of the acquisition price and date of issue of the units you receive. You will need these details to calculate your capital gain or loss, should you ultimately dispose of these units.

Timing the market

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.” – Peter Lynch, fund manager

Timing the market is basically trying to predict the future. Sadly, we don’t have a crystal ball. Lynch makes this pretty clear, reinforcing that some of the smartest people, who spend their days pouring over balance sheets, can’t time the market either.

Testament to this is the results from a 1904 study of 4000 brokerage accounts¹. The survey found that investors who lived further away from the brokerage house, on average, had a better investment return. This was because they had to physically go into the brokerage house to trade, and as a result tended to trade less.

Investors who initially did well eventually fell to overconfidence by trading in larger amounts and more frequently.

Not much has changed since then. Over the last 30 years² the S&P 500 index returned 10.65% per annum, but the average equity fund investor returned just 7.13% per annum³. This is because the average equity fund investor may act on emotion and over-trade during short-term market volatility.

Those who stay invested in a well-diversified portfolio over a long period will generally do better than those who try to profit from changes in the market.

Dollar cost averaging

“The individual investor should act consistently as an investor and not as a speculator” – Benjamin Graham, author of The Intelligent Investor

Consistency is key when it comes to investing, and Graham is encouraging investors to remain consistent rather than speculate on what might happen in markets.

This is where dollar cost averaging comes in. It involves investing the same amount of money at set intervals over a number of years, whether market prices are up or down.

When prices are up, your fixed dollar amount will buy fewer units or shares. When they are down, your regular investment will buy more. The point of dollar cost averaging is not to try and pick whether markets are going to rise or fall but rather to remove the concept of speculating from the equation.

Investing rationally rather than emotionally

“The most important quality for an investor is temperament not intellect” – Warren Buffett, chief executive of Berkshire Hathaway

Sometimes our emotions can impact our investment choices, which can be to our detriment.

As we enter bull markets, the optimism, thrill, and excitement of rising values may lead us to think that making gains on investments will be easy. Sometimes this can lead us to increase our level of risk at a time when we should be more cautious.

On the other hand, when markets are in a downturn, we may be presented with strong buying opportunities. However, anxiety, fear and panic may prevent us from investing. In some cases, these emotions of desperation are enough to drive us to exit markets altogether – at precisely the wrong time.

Buffett’s adage reminds us to check in and ask ourselves whether our decisions are being driven by our emotions or by reason.

Summary

The lessons offered by Munger, Lynch, Graham and Buffet come down to two things: rationality and consistency. Their combined wisdom teaches us to ignore any noise surrounding our investment journey, and stay in the market with consistency throughout any ups and downs to enhance performance outcomes.

References:

1. The Pitfalls of Speculation, Thomas Gibson 1906.
2. From 1/1/1992 – 31/12/2021.
3. Dalbar QAIB 2022 study, Morningstar, Inc. ‘Average equity fund investor’ as determined by Dalbar. Past performance is not an indication of future performance.