Man, check out this chart of the Aussie Sharemarket. Investing in shares must be so easy!
Well, to some extent it is, but it’s usually human nature that gets in the way of successful long-term investing.
Our natural instincts that served us so well in the caveman days, are strangely still with us.
Sadly, they’re not a great help when it comes to investing.
We naturally feel safety in numbers. It feels comfortable to do what everyone else is doing and we instinctively want to avoid loss by clinging to what we have.
Our instincts often pop up at the wrong time and make us do the opposite of what we should be doing. This is especially true in the world of investing.
You see that picture above? It’s a chart showing the returns from the Aussie Sharemarket going back all the way to 1900. It includes the GFC and every other crash over the years.
Nearly 12% per annum is a very respectable return. Over 100 years of magical compounding goodness doing it’s thing!
$1 turns into 400k. Nothing to scoff at.
With such great returns over such a long time, surely everyone loves the sharemarket and can’t get their money invested fast enough? Mmm, not quite.
Unfortunately, the sharemarket isn’t a sweet little darling that steadily goes up year after year, in the safe and predictable manner that our human nature desires. Nope….sometimes, it goes down…. a lot!!
At least nobody would’ve lost money during that time, right? Well, this is where our human emotions come in and mess things up for us.
The problem is when something scary happens, like a market crash, people’s natural urge is to flee from the danger. So they sell out, at probably the worst possible time. Having locked in a loss by selling and too emotionally scarred to re-enter, they give up on the sharemarket altogether.
Crashes often follow periods of huge returns and general euphoria about large future gains. At this point, the market gets too inflated and future expectations are unrealistic. Eventually there is a trigger for the market to reset itself. Often some type of financial catastrophe occurs and the market no longer believes it’s own hype. Then the future doesn’t look so rosy and people start getting worried. The selling starts….
Market crashes are inevitable, when mass panic occurs and everyone wants to cash in and go home. With all that selling pressure, there is nowhere for the market to go, but down.
It sounds reasonable to try and avoid this danger, perhaps by selling out or avoiding the sharemarket altogether. But the thing is, life goes on. People still eat, drive around, entertain themselves, buy things and generally just go on living their lives. So the bulk of company earnings and dividends don’t change anywhere near as much as the share prices do.
This is why you need to….
Ignore day-to-day share prices
Believe it or not, the share price doesn’t always reflect what’s really going on.
Whether the share price is up or down today is no reflection of whether people are shopping at Woolworths or Coles. Today’s share price doesn’t tell you whether people are still paying their home loan to the Commonwealth Bank, or if they refinanced to a smaller lender.
If Commonwealth shares went up 2%, does that mean they earned 2% more banking business today? No, there’s simply no way of knowing that. These companies are just going about their daily business. Regardless of what the traders and gamblers are doing on the market that day.
Day-to-day business fluctuations are recorded behind the scenes and reported to the market every 6 months or so, that’s when we really know what happened over that period. Basically, the daily market movements just tell us what people are willing to pay for a companies’ shares that day.
Take the Buffett approach
Warren Buffett likes to think of the market as a bipolar fellow, named Mr Market. Some days he is especially sad and depressed and see’s only a bleak future ahead so he is only offering you a very low price to buy or sell shares. Some days he’s euphoric and can see only good times ahead and may offer you a very high price. It’s up to you whether you take up his offers or not. You can simply ignore him, he doesn’t mind.
The quote ends by telling you not to fall under the influence of Mr Market. Don’t let him dictate your mood and become fearful or too excited.
Buffett also says “I like buying quality merchandise when it’s marked down, whether it’s socks or stocks.”
Stock up on shares when they’re on sale!
There are many benefits for the buyer of shares when the market is down in the dumps.
Lower prices gives you a chance to buy more shares at a cheaper price, so you can take advantage of Mr Market when he’s depressed.
If you are putting a set dollar amount into shares each month, when the market is down, your money will go further – you’ll get more shares for your money.
Better dividend yields are on offer when markets are scary, buying you more dividend income.
Lastly, if you’re a monthly buyer of shares over the long term, it’s not logical to want them to increase in price. Being a buyer of shares, over your lifetime, you’re better off if the price stays the same, or even goes down. The income still flows to you and the companies will raise dividends over time.
It’s clearly better if the price of anything we’re going to be buying a lot of, gets cheaper. The same is true for shares.
Again, our natural behaviour is, we only get excited when our investments go up. We need to embrace the other side of this coin and become excited at the chance to buy more investments at a lower price!
If you’re investing in a good spread of companies, via Listed Investment Companies (LICs), the value of your portfolio will increase considerably over time, following company profits. The point I’m trying to make is, the value of your shares will certainly make you richer over time, but it’s not the main game.
Remember, what we really want is the cash profits (dividends), not the paper profits. It’s all about the income stream. It’s not about the ups and downs.
Focus on the asset
Falling share prices will not affect financially independent folks who are living off dividends, nor should it be a source of worry. Here’s why….
If we were living off the rental income from a house that we’d paid off, should we care if the house went up in price one week and down in price the next week? No, of course not! All we should be concerned about is, whether the income is going to pay our bills and if it will keep pace with inflation. So why would we panic if our shares go up one week and down the next, if the dividend income is paying the bills? We shouldn’t!
Treat your shares like you would treat your house, as a long term holding. In future decades, that huge spread of companies you own, via LICs or index funds, is bound to do well and the income will head upwards over time, alongside company profits.
Companies will continue paying their dividends to shareholders from cash profits they’ve made, regardless of what the share price is doing.
Paying attention to the earnings and dividends of the company makes more sense to me, rather than checking the price on a daily basis, since it’s the dividends that will be paying our bills. Earnings and dividends don’t fluctuate anywhere near as much as share prices, so your ride is a lot smoother as a dividend investor.
What if we know a crash is coming?
There is always a crash coming, we just don’t know when it will occur. Sometimes it looks obvious in hindsight, but the truth is, very few saw the GFC coming. Keeping your savings in cash or worse, selling your shares to seek out safety, is very likely a poor choice.
A great investor, Peter Lynch, once said “More money has been lost by preparing for market crashes, than has been lost in the crashes themselves”. This is because, if people convince themselves a crash is coming soon, they may simply not invest or will sell what they already own to seek the safety of a savings account and miss out on all the market gains.
He also says, the key to making money in stocks, is to simply not get scared out of them. Even if you had invested in the market on the worst day of the year, in the decades to come, your investment would be worth much more and would continue to spit out a steady income stream, year after year.
Nobody can consistently time the market. Not even Warren Buffett. There is simply no need. The long term returns are super attractive, even despite all the ups and downs, for as long as the markets have existed.
Keep adding money to your investments every month, using the power of Dollar Cost Averaging. This technique of committed investing means, you’ll buy less shares when markets are expensive and more shares when markets are cheap. It’s a winning strategy that averages out your purchase prices over time.
Keeping costs low
One of the key skills needed to reach financial independence is the art of optimising or eliminating expenses. We can transfer this principle to our investing too.
By taking a long term buy and hold approach, we only incur brokerage once and each investment is left to keep compounding, capital gains tax free. The traders out there need to make way higher returns just to keep up with us, once they account for capital gains taxes and extra brokerage costs. See an article from Pete Wargent here, to see a great example of this.
I use CMC Stockbroking, as my online broker. They’re very low-cost and easy to use.
Stay focused & don’t fiddle
Put your head down and stay focused on the end goal. It doesn’t matter what the market is doing. By focusing on the dividends instead of the share prices, it’s a much more smooth and steady ride.
The best part is, you get closer to financial independence with every single monthly investment. Every share purchase increases the dividends you’ll receive, which you can use to buy more shares to get you closer again.
This puts the power back in your hands!
When the market goes down, it’s scary, but we need to hold our nerve if we want to achieve those attractive long term returns. Our instincts tell us “Don’t just sit there, do something!” right at the time when the opposite approach is best… “Don’t just do something, sit there!”
So now you know, the sharemarket is not a scary beast that gobbles up your money. There’s only one thing you need to do….
Save, and invest those savings in quality LICs… then, just sit there 🙂
Note – This post is a long one, but it’s an important mental hurdle to get over, especially for property-only investors (like I once was) and anyone who feels the sharemarket is some kind of crazy casino. It took me a while to learn these things. My ignorance made me scared of the sharemarket at first. There is a link below to some videos that really cleared away the fog and helped me learn about how to approach shares rationally, explained in a much better way than I ever could!