These simple steps can smooth your investing returns, writes The Motley Fool.
As recently as early July, the S&P/ASX 200 index (INDEXASX:XJO) stood comfortably above 4,600. Happy days were here, we thought.
But by early August, the index was back below 4,000 — and on several occasions dipped below that level, most recently as early October. On 4 October, it closed at 3,872.
All of which goes to show that we shouldn't take today's level of around 4,200 or so for granted. From here, the index could go anywhere — and with it, superannuation accounts, savings, incomes, and the built-up wealth of countless investors.
Worrying times
In short, volatile conditions look likely to be a feature of the investing climate over the short-to-medium term. Whatever comes of the latest European crisis summit, high national debts, and tepid economic growth aren't going to go away any time soon.
So what's an investor to do? Sadly, history already tells us what many investors are doing: cutting and running, deciding that the sharemarket isn't for them, and taking their losses on the chin.
Fortunately, there are better options.
Diversification
First, spread your wealth — and your risks. A portfolio spread across asset classes will always be more resilient to adversity than a portfolio concentrated on just one asset class.
That's why investors are urged to spread their portfolios between shares, bonds and cash. When the sharemarket is racing away, cash may not seem exciting. But when it's plunging, it offers steady returns and reassurance.
Take a look at a table produced by fund management firm Fidelity, showing the returns that asset classes enjoyed during various economic conditions over the period 1973-2010. Each class enjoyed booms, to be sure — but also busts.
| Economy | Bonds | Stocks | Commodities | Cash |
|---|---|---|---|---|
| Reflation | 10.6% | -0.1% | -25.3% | 3.4% |
| Recovery | 6.7% | 20.7% | -8.2% | 2.1% |
| Overheating | 0.0% | 8.1% | 18.9% | 0.8% |
| Stagflation | -1.1% | -14.9% | 29.6% | -0.8% |
| Average return | 3.4% | 5.2% | 4.0% | 1.3% |
Source: Fidelity
Effective diversification improves portfolio efficiency, says Fidelity, by helping to ensure that for any given level of risk, investors maximise their returns.
What's more, it adds, multi-asset funds have the potential to boost returns further through tactical asset allocation — where weightings are tweaked according to prevailing economic conditions.
And you don't have to put your money in a fund to achieve that, although many investors do, of course.
A judiciously-acquired mix of shares, ETFs and cash would do much the same trick, too — and arguably at lower cost.
Hold for the long term
Here at The Motley Fool, we're generally buy-and-hold investors.
That's because investment churn saps performance through trading costs. It's generally better, goes the logic, to take your time over the selection of a share, pick decent businesses run by skilled managers, and let them get on with the job of building your wealth.
It's certainly a strategy that has worked well for Warren Buffett, of course. "When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever," he told investors in his 1988 letter to shareholders.
Over the years, there have been all sorts of sharemarket crashes and periods of under-performance — the causes and durations of which are long since lost in the mists of time.
What we doknow is that markets eventually recover, and carry on heading upwards — carrying our shares, and investment wealth, with them.High-yield equities
Always a popular pick, high-yielding blue chips have the size to resist adversity, while continuing to throw off cash year after year.
Quite simply, defensive consumer-centric stocks such as Telstra Corporation Limited (ASX: TLS), Wesfarmers Limited (ASX: WES) and Woolworths Limited (ASX: WOW) have been rewarding shareholders with dividends for years.
All four banks – Australia & New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) – have been relatively stable and prodigious dividend payers for years.
And those dividends play a useful role in countering market volatility, argues Fidelity's Dominic Rossi. For while many investors are still deeply rooted in the concept of investing for straightforward capital growth in equities, the investment landscape has changed, he reckons.
In a lower growth and interest rate environment for developed economies, he points out, it now makes sense to look at equities from a total return perspective: capital growth and accumulated income over time, too.
In short, remember the importance of compounding and dividend reinvestment: over time, compounding even seemingly paltry dividend payments can contribute significantly to total returns.
The Foolish bottom line
And the good news is that while markets today are just as volatile and unpredictable as they've been at similar points in the past, investors today have a huge advantage over their predecessors.
Simply put, in times past the cost of taking some of these preventative measures was simply prohibitive. Funds were expensive; brokers' dealing costs astronomical, and low-cost ETFs and index tracking funds didn't exist.
Today, the world of investment has been transformed. Markets may fluctuate erratically — but that doesn't mean that your portfolio, and the investment returns from it, must also follow suit.
If you are looking a stock paying an above average dividend, readers need look no further than The Motley Fool's Top Stock For 2012. Click here now to request this special report, while it's still free and available.
This article authorised by Bruce Jackson.
