In my morning reading time today I came across an item written by William McNabb, the Vanguard Group's CEO. The explanations are from a US perspective but are definitely transferable into the Australian context. The following is taken directly from his article:
Respect risk. Investments with the potential for great returns also carry great risks. It's tempting to only look at one side of the equation. This was perhaps the most obvious lesson learned during 2008, when risky and complex investment strategies failed en masse. Unfortunately, this lesson gets forgotten in every investment boom and relearned in each ensuing bust. That makes this advice seem too late-but, in reality, it can help us respond to the recent setback and keep us alert when investors once again fail to appreciate the market's true risks. If you've suffered a significant decline in your investment portfolios, you may be tempted to look for ways to play "catch up." Don't. Simply put, you can't invest your way out of a low account balance. And it's dangerous to try.
Save aggressively. For 2009, I'm more convinced than ever that investors of all types need to save aggressively, or even "oversave." The sad truth is that Americans have been relatively poor savers in recent years. It can be hard-and discouraging-to save and invest money during a market downturn. The thinking often goes, "Why put money in the stock market when it's been posting poor results?" But it may be wiser to ask, "Are you better off making contributions to your retirement account when the Dow Jones Industrial Average is near 8,000 points (where it's been recently) or near 14,000 (where it peaked in October 2007)?"
Be balanced and diversified. Creating a portfolio with a mix of different asset classes (stock, bond, and money market funds) is critical to limiting volatility. Maintaining the appropriate mix (based on your risk tolerance and time horizon) is critical to ensuring that your portfolio continues to reflect your risk and return parameters through good markets and bad. But this discipline can be uncomfortable. Many of Vanguard's own balanced funds, for example, are required to maintain a certain ratio between their stock and bond holdings. That often means that when their stock portfolios perform well, the fund managers must buy bonds; when stocks do poorly, they must buy more stocks. It feels counterintuitive, and from an emotional standpoint, it can be a challenge for many investors. But it's a sensible approach that, over time, has produced solid results. I noted above that stocks have averaged an annual return of 9.6% over the past 82 years. A hypothetical portfolio consisting of half stocks and half corporate bonds would have averaged an annual 8.2% over that same span.
I think the comments are very pertinent and well worth sharing. The full text of the article can be found at - Thee Investment Maxims from vanguard's CEO.