Lessons I wish I knew earlier as an investor
A few books, articles and studies that have helped me form my investment strategy
I recently laid out my investment strategy. It’s simple. I focus on asset allocation and factors within my control, such as minimising fees and taxes and how much I save. I’ve found that this approach gives me better results than constantly trying to pick stocks.
It’s not a difficult approach to come to, but it is based on years of sound research (in a personal and professional capacity), and understanding the type of investor I am. This only comes after looking in the rearview mirror and knowing when you’ve failed and having the humility to course correct.
I think the journey is an important part of understanding what will make you a successful investor. However, there are some resources that I wish I came across a little sooner. They are in no particular order and this article is the first of a two-part series.
The Little Book of Common-Sense Investing, John Bogle
The Little Book of Common-Sense Investing is commonly placed at the top of lists of suggestions for first time investors. It is written by former Vanguard CEO and Founder, the late John Bogle. There are many reasons that investors like the book. Bogle makes a compelling case for passive investing. He takes an unusual perspective – someone from the financial product industry, disparaging most of the financial product industry. One of the main lessons that I got from this book is the importance of reducing fees to protect your total return.
However, an even more pertinent lesson it taught me was how important it is to open your eyes to new perspectives. I had just come from working at an active manager, where my job was to read and understand why active management was good for clients.
One day at work I opined that passively managed investments could find a place in a diversified portfolio, alongside active management. The next day, a colleague had put a printout of a graph on my desk. It was the performance of the ASX 200 index against a microcap fund that had recently achieved a 60% p.a return. A note accompanied it. ‘Enjoy the very long time you have until retirement.’
Three years in this environment at the beginning of my investing journey meant that I had a strong sense of confirmation bias toward active management. In short, this means that I believed strongly in this perspective as I had little to no exposure to any others. Being surrounded by proponents of active management who were vocal about the ‘right’ way to invest had not given me much opportunity to consider what might actually be right for me.
The Little Book of Common-Sense Investing is a great book in its own right. It is also a masterclass in someone passionately advocating for their cause. Bogle’s perspective had been quashed in the environment in which I started my early career. Bogle is compelling in this book, advocating for achieving the ‘average’ return of the market.
I learnt a healthy lesson – always be open-minded to other perspectives, especially with investing. On the other side of every trade is someone who has the opposite expectations for the asset you are selling.
Shane Oliver’s five charts
I had the pleasure of meeting Shane at our Morningstar Investment Conference for Individual Investors. As we were waiting for him to get on stage, I told him that his article on investing charts is something I think about often - and it also got me a promotion.
I presented Shane’s charts for a pitch I had to prepare about how to make investing approachable for the everyday Aussie. I think that his graphs are as appropriate for new investors as they are for seasoned investors – they are reminders of the fundamentals. They are grounding during times of volatility.
They say a picture is worth a thousand words. These pictures remind us why we take on risk and invest in equities. It reminds us that our behaviour is a key driver of the outcomes we achieve. It concisely demonstrates how our emotions can magnify the severity of market swings. It is sage advice that investors will always have something to worry about but shares have succeeded in the long-term regardless.
I’ve included two versions – the original five charts on investing to keep in mind, and a second iteration of 9 important things that he has learned from investing for forty years.
Ibbotson’s studies on asset allocation
I mentioned my investment strategy earlier. It is based on technical and circumstantial reasons. The technical reasons are grounded in Ibbotson and Kaplan’s report on the important of asset allocation. Ibbotson says in this report:
‘Asset allocation policy gives us the passive return (beta return), and the remainder of the return is the active return (alpha or excess return). The alpha sums to zero across all portfolios (before costs) because on average, managers do not beat the market. In aggregate, the gross active return is zero. Therefore, on average, the passive asset allocation policy determines 100 percent of the return before costs and somewhat more than 100 percent of the return after costs. The 100 percent answer pertains to the all-inclusive market portfolio and is a mathematical identity—at the aggregate level.’
Ibbotson’s point is that because most investors can’t put together a portfolio of individual investments that beat the index, the only driver of returns is the asset allocation of their overall portfolios.
What I take from this is that I have little interest or proclivity to pick individual shares. I hold some direct equities in my portfolio that I have high conviction in. However, my investment strategy largely focuses on asset allocation. It is the most important driver of returns. I am much more focused on investing regularly in the right asset allocation and committing over the long-term. I believe that will provide more of a difference to my outcome than choosing between two stocks.
Common stocks, uncommon profits, Phil Fisher
The main lesson for many investors from Phil Fisher’s book Common Stocks, Uncommon Profits is the 15 factors that he suggests investors should focus on to pick high quality stocks. Many of these factors are timeless tests for strong companies. His book focuses on growth stocks, but the lesson that I got from his book is pertinent to all stocks.
Many investors know how important a long-term time horizon is for building wealth. The same goes for companies. Fisher thinks that many companies are too focused on near-term earnings. This focus means they may forego taking actions that will benefit the growth of the company in the long-term to avoid a short-term hit to earnings.
A CEO’s main job is capital allocation. They must decide where funds are being directed and for what purpose. There must be a balance between rewarding existing shareholders with immediate income, through the form of dividends, and investing back into the business to ensure that the business continues to grow.
Fisher addresses the emphasis that investors place on short-term rewards regardless of what is best for the long-term. In the case of companies, these pressures result in not investing in the business and instead keeping earnings and dividend payouts high. This is a fine strategy for mature companies but is not in the best interests of companies with room to grow and opportunities to seize.
Australian companies are trigger happy with dividends. Our markets reward companies that distribute income, especially with the potential added benefits of franking credits. Fisher’s book has given me an important reminder for diversification within my equity exposure which is especially important where I have long time horizons for companies to reach their potential.
When I started investing, I invested almost exclusively in Australian equities. At almost all points of an investor’s journey the benefits of diversification are preached. It didn’t take me long to understand that diversification is important.
The issue arises when I invest in international equities, but I am looking at the franking credits that are attached to Aussie equities. I’m looking at the historical outperformance of Aussie equities against most other international markets. I’m looking at the attractive yields. There are many convincing arguments to make me want to reduce my international equity exposure.
Fisher’s simple explanation for focusing on the long-term with a portfolio or company is a grounding lesson that strengthens the principle that knowing what you’re invested in and why can help drown out the noise that can make you doubt your decisions.
Final thoughts
There are many valuable insights and perspectives that you can pull from these resources. I have gone through the lessons that have resonated with me the most and have stuck with me during my investing journey. In my next article, I will go through a few podcasts and books that helps me stay on track.
