Our previous blog on investment beliefs highlighted five beliefs that could damage future investment performance.We follow on with a further set of beliefs that can be equally devastating. To recap:
- Belief #1: Money in the bank is safe.
- Belief #2: Investing is optional.
- Belief #3: Buying and selling shares is the way to make money.
- Belief #4: Investing and speculating are the same things.
- Belief #5: I can lose all my money if markets crash.
We follow on with a further set of beliefs that can be equally devastating.
Belief #6: Investment success means beating the “market”.
Investment success means making money to enable you to live the way you want to live. Making money is defined as an absolute return.
Comparing your returns to a benchmark like an index means it is possible to beat the market and still lose money. Beating the index while losing money is not helpful.
Belief #7: The primary goal of investing is capital gain.
The great investors focus on the income an investment can generate. Capital gains are a by-product of selecting investments that produce increasing volumes of cash. The financial press focuses on share prices far more than dividends, as evidenced by the minute-by-minute obsession with price movements on TV shows and computer screens.
Yet, dividends are a significant component of the overall return of the market and therefore cannot be ignored.
The great investors, focus on dividend-paying investments because:
- Dividends are a significant component of the overall return
- Dividends are paid to shareholders in cash on a regular basis, creating a growing income stream
- The dividends can be reinvested to unleash the power of compounding.
- Dividends provide income often taxed at lower rates than other income as the company has paid a substantial tax on its profit already before paying the dividend.
- Dividend-paying companies have to prove their ability to generate future cash flow to pay a dividend.
Belief #8: Great investors focus on generating big gains.
Great investors concentrate on avoiding big losses.
Anything can happen in the stock market at any time. Careful share selection and disciplined buying at the correct prices can help avoid permanent loss of capital.
Belief #9: I have lost money if a share price declines.
Share prices do not always reflect the underlying value of the businesses that they represent. The value of selected businesses is determined by analysing the cash flows of those businesses.
In a 2009 BBC interview, Charlie Munger stated that “This is a 3rd time Warren and I have seen our holdings in Berkshire go down top tick to bottom tick by 50%”. Charlie Munger and Warren Buffett understand the value of Berkshire Hathaway’s cash flows and therefore do not panic and sell when the price declines. On the contrary, they know the value so well that they buy more shares when prices crash.
Belief #10: Warren Buffett says buy index funds
Buffett is clear. Don’t pay high fees for Hedge Funds, actively managed Mutual Funds (Unit Trusts) and other expensive financial products.
He recommends investing in a few good businesses that you know well and can buy at a decent price. These businesses should have clear advantages that are sustainable for the long term.
Warren Buffett does recommend indexing as an alternative to understanding, ideal for the “know nothing” investor who does not, and has no desire or capability to, understand how companies work. He specifically recommends the Vanguard S&P 500 Index Fund (VOO) for these investors.
At AXIAM, we believe Warren Buffett when he says “I think sound investing can make you very wealthy if you are not in too big of a hurry. And it never makes you poor, which is better”. We focus on a long-term investment strategy built on 11 Investment Principles gleaned from the world’s great investors like Warren Buffett, Howard Marks and Charlie Munger. Contact our fund managers or sign up for our newsletter if you would like to learn more about investing your capital to provide ongoing retirement income.