A combination of the blanket news coverage of economic worries, the associated information avalanche we are now exposed to and our innate fascination with crises is likely making us worse investors. We’re more fearful, more jittery and more focused on the short-term. With the year drawing to a close, now is a good time to reflect on some key lessons from 2014.
Lesson 1: Turn down the noise
This year has seen an endless list of worries. Ukraine, a property collapse in China, the end of quantitative easing and talk of rate hikes in the US, global deflation, renewed weakness in Europe, geopolitical instability in the Middle East, protests in Hong Kong, Ebola, Australian budget cutbacks, the collapse of the iron ore price, and so on.
Last year was the same with the US fiscal cliff, worries about Italy and Spain and US Federal Reserve tapering. Similarly, 2012 was just as packed with worries… you get the picture. While not to deny the current worry list, it’s really nothing new. The global economy has had plenty of difficult phases in the past. And it got over them.
The reality is that much of this financial news is noise – random moves in economic data due to statistical anomalies rather than a fundamental swing in the economy, shifts in share prices and currencies that reflect swings in sentiment on the day, constant chatter about what it all means. And of course it’s well known that ‘bad news sells’.
Given all this, there are four things investors should remind themselves of:
- Shares and other growth assets have historically climbed a wall of worry and they will most likely continue to do so.
- Turn the volume down on the ‘news’ front, i.e. consume less of it.
- Adopt a long-term strategy and stick to it.
- The best opportunities in investing often arise when many are engulfed by doom and gloom and the market is cheap.
Lesson 2: Don’t ignore dividends
Up until the 1950s most share investors were long-term investors who bought stocks for their dividend income. This changed in the 1960s as bond yields rose on the back of inflation and investors started to shift focus to capital growth. However, thanks to the volatility seen over the last decade or so, and an increased focus on investment income as baby boomers retire, interest in dividends has been on the rise.
Below are some things to note about dividends:
- Dividends matter in terms of returns from shares. It has been found that higher dividend pay-outs lead to higher earnings growth, and higher earnings growth contributes to higher returns from shares over the long-term.
- Concerns about the sustainability of dividends fly in the face of all the evidence that companies like to manage dividend expectations smoothly – they rarely raise the level of dividends if they think it will be unsustainable.
- Decent dividend yields provide security during uncertain times. Dividends provide a stable contribution to the total return from shares over time, compared to the year-to-year volatility in capital gains.
- Investor demand for stocks paying decent dividends will be supported over the years ahead as more baby boomers retire and focus on income generation.
- With the scope for capital growth from shares, diminished thanks to relatively high price-to-earnings ratios, dividends will comprise a much higher proportion of total equity returns than in recent decades. Around half of the total return from Australian shares over the next five to 10 years is likely to come from dividends, once allowance is made for franking credits.
- Finally, dividends provide good income. Grossed up for franking credits, the annual income flow from dividends on Australian shares is currently around 5.7% – compare that to a term deposit rate of around 3.5%.
Dividends provide a great contribution to returns, a degree of protection during bear markets and a great income flow. Investors should always allow for them in their investment decisions.
Lesson 3: Be wary of herd mentality
The Japanese bubble of the late 1980s, US tech stocks in the late 1990s, US housing and dodgy credit in the mid-2000s all had one thing in common – investors had jumped on a bandwagon in a euphoric mass. This resulted in some assets becoming over-loved and overvalued and ripe for a crash that, of course, happened.
The trouble with herd mentality from an investment perspective is sourced in investor psychology. It is well known that individuals suffer from lapses of logic. For example, they tend to:
- Down-play uncertainty and project the current state of the world into the future;
- Give more weight to recent spectacular or personal experiences in assessing the probability of events;
- Focus on occurrences that draw attention to themselves;
- Regard events as obvious in hindsight;
- Be overly conservative in adjusting their expectations to new information and do so slowly over time;
- Ignore information conflicting with past decisions.
And of course these lapses are reinforced and magnified when many investors start thinking the same way. The mini pullbacks in share prices seen early in 2014, and then more recently provide classic examples of what can happen when the crowd gets a bit too optimistic. This then sets shares up for a pullback, relieving the optimism. However, we haven’t yet seen the sort of euphoria that is usually seen at major market tops. The key implication for investors is that, while it may feel uncomfortable, successful investing often requires going against the crowd – particularly when the crowd is at extremes of bullishness and bearishness. Various investor sentiment and positioning surveys provide a guide.
Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.