22 years of research tells me this.
What are the keys to financial security?
You must live within your means. Simple.What does living within your means really mean? It means that to enjoy financial security, you must pursue a financial strategy something like the following.
Save.Before you retire, you must demonstrate good savings habits. You must save. Very simplistically, the more you save, the higher the standard of living you are likely to be able to enjoy in retirement. You can control your saving. You cannot control what investment returns you will experience.
In retirement, adjust your spending to the size of your investment portfolio.For example, one effective strategy is to calculate the size of your investment portfolio each year, and spend no more than 4% of the balance. If you can do this, then you can survive the tough periods so you can enjoy the good periods which usually follow.
Discipline.There is no escaping that to be financially secure, you must demonstrate the discipline of saving and also keeping your cost of living within your means.
The rest of the material on this page provides some of the historical evidence behind the above views.
The long-term variability of investment returns can pose a threat to your financial security.
This is very unfortunate because it would make life so much easier if we could count on the markets.
Bottom lines keys to financial security:
Some of the things I have learned about investments.
You can have negative real returns over 30 years.For example, in the UK at the beginning of the 1900s, there was a period that had negative real returns compounded over 30 years. So a strategy of "Time in the market rather than timing" can at times be dangerous to your financial health. Some times it works. Some times it does not.
Another example that you might look to, is Japanese shares 1990 to 2009.
Unfortunately timing does matter a lot.This is unfortunate because it makes the challenge of investing far more difficult.
Market timing is a challenge.> Market timing is a percentage game. You are not going to get market timing right all the time, because among other things, the unexpected keeps happening. There are different issues around short-term market timing as compared to long-term market timing. Market timing requires discipline.
Long-term (eg 30-year) investment returns vary dramatically. Long-term investment returns vary dramatically from one country to the next, and from one century to the next. While US, UK and Australia might have experienced approximately 6%pa real returns from shares over the last 50 years, history suggests that a country might experience a real return of less than 3%pa over 100 years as some Europeans countries like Belgium and Italy have over the last 100 years.
Share markets tend to have 20 exceptionally good years followed by 15 years of bad returns - on broad averages.But there is a lot of variability between cycles.
Big crashes in share markets tend to coincide with big crashes in real estate markets. This is from a study by the US Federal Reserve, looking at last 200 years. And in these big real estate crashes, real estate tends to fall as far as shares.
Long-term buy-and-hold investors never make money by buying during a bubble.
Economic depressions are a normal part of the investment cycle.They are a behavioural effect relating to very long debt bubble cycles.
Gearing takes you forward half the time, and backwards half the time. This is true even if you ignore transaction costs and taxes. So if you want to gear into markets, you need to learn how to time markets first. Otherwise you are gambling with your future.
Based on Australian experience over the last 100 years, you should expect a crash of 50% approximately every 20 years.Geared investors beware. I suspect many geared investors do not realise that they are gambling, and don't realise how much the odds are stacked against them.
Shares are not a sure thing.History indicates that at the end of the regular 20 year bull market in shares, "investors come to believe that investing in shares is a SURE THING."
It is important the consider the big emerging trends. Emerging Asia is a very importan trend now.
Long cycles are important.
The investment herd tends to buy at the top and sell at the bottom.Don't be part of the herd. Investors prefer travelling with the herd because it feels more comfortable because by being part of the herd, the investors behaviour is reinforced by their peers. Contrarian investing can be smart investing.
Markets tend to go through periods of over-optimism followed by periods of over-pessimism. Durig the periods of over-optimism, markets tend to be excessively expensive. During periods of over-pessimism, markets tend to be excessively cheap). These cycles can be 20 years long. Make this work in your favour.
No sure thing when it comes to investing.There is no such thing as an absolutely certain thing when it comes to investing. Therefore, don't bet everything on a single outcome because the unexpected regularly happens.
Always consider the downside risk?What if you have got it wrong? Since the unexpected regularly happens, always ponder on what will happen if the investment outcome you are looking for does not occur, or worse, if the reverse occurs.
Government bonds also have risk.There are many, including myself, who believe that western government bonds are in a bubble that will burst at some point over the next few years.
Don't pay more tax than you need to.
Learn how investment markets work. It is important to learn about investment markets, so you can make them work for you. Learn how to live with market volatility - it can work for you. Can you master your emotions when markets are emotional?
Money is not everything. Money is not everything in life, but it gives you choices in your life. It is a means and not the ultimate end-goal.
Do not let your emotions get tangled up with your investment decisions.The best investment decisions are made when you are emotionally dispassionate (ambivalent) to the outcome. If you find your emotions are inflamed when making an investment decisions, read this is a warning that you may be about to make a bad decision.
It is generally better to sell your dogs and let your winners run.Unfortunately human beings are emotionally wired to do the reverse. If you can change your behaviour, you are likely to do better. (Behavioural Finance).
The above points might sounds easy, but it is hard to get these right in practice.
One of the best definitions of risk that I have seen was that which was on the US Security Exchange Commission (SEC) web site in May 2004. It said as follows:
There is a “tendency of capitalism to grave instability”. In “The Economy Since The Wars”, John Kenneth
Galbraith notes that “built into the systems are recurrent episodes of devastation”. Kerr Neilson 12/4/00 also
reports George Soros‘s view “that markets are inherently unstable.”