Property 101: Seven rules for SMSF investors

Investing during times of market stress and volatility can be difficult. For this reason it’s useful for SMSF investors to keep a key set of things – call them rules – in mind.

The seven key rules, in my view, are: be aware that there is always a cycle; invest for the long term; turn down the noise; buy low and sell high; beware of the crowd; diversify and focus on investments offering a sustainable cash flow.

1. Be aware that there is always a cycle

The historical experience of investment markets – be they bonds, shares, property or infrastructure – constantly reminds us they go through cyclical phases of good times and bad. Some are short term, such as occasional corrections. Some are medium term, such as those that relate to the three to five year business cycle. Some are longer, such as the secular swings seen over 10 to 20 year periods in shares. But all eventually contain the seeds of their own reversal. The trouble with cycles is that they can throw investors out of a well thought out investment strategy that aims to take advantage of long term returns and can cause problems for investors when they are in or close to retirement. In saying this, cycles can also create opportunities.

2. Invest for the long term

The best way for most investors to avoid losing at investments is to invest for the long term. Get a long term plan that suits your level of wealth, age and tolerance of volatility and stick to it. This may involve a high exposure to shares and property when you are young or have plenty of funds to invest when you are in retirement and still have your day to day needs covered. Alternatively if you can’t afford to take a long term approach or can’t tolerate short term volatility then it is worth considering investing in funds that use strategies like dynamic asset allocation to target a particular goal – be that in relation to a return level or cash flow. Such approaches are also worth considering if you want to try and take advantage of the opportunities that volatility in investment markets through up.

3. Turn down the noise and focus on the right asset mix

The combination of too much information has turned investing into a daily soap opera – as we go from worrying about one thing after another. Once you have worked out a strategy that is right for you, it’s important to turn down the noise on the information flow surrounding investment markets. This also involves keeping your investment strategy relatively simple – lots of time can be wasted on fretting over individual shares or managed funds – which is just a distraction from making sure you have the right asset mix as it’s your asset allocation that will mainly drive the return you will get.

4. Buy low, sell high

One reality of investing is that the price you pay for an investment or asset matters a lot in terms of the return you will get. It stands to reason that the cheaper you buy an asset the higher its prospective return will be and vice versa, all other things being equal. If you do have to trade or move your investments around then remember to buy when markets are down and sell when they are up.

5. Beware the crowd and a herd mentality

The issue with crowds is that eventually everyone who wants to buy will do so and then the only way is down (and vice versa during periods of panic). As Warren Buffet once said the key is to "be fearful when others are greedy and greedy when others are fearful".

6. Diversify

This is a no brainer. Don’t put all your eggs in one basket as the old saying goes. Unfortunately, plenty do. Through last decade many questioned the value of holding global shares in their investment portfolios as Australian shares were doing so well. Interestingly, for the last five or so years global shares have been far better performers and have proven their worth.

It appears that common approaches in SMSF funds are to have one or two high-yielding and popular shares and a term deposit. This could potentially leave an investor very exposed to either a very low return oif something goes wrong in the high -yield share that they’re invested in. By the same token, don’t over diversify with multiple – say greater than 30 – shares and/or managed funds as this may just add complexity without any real benefit.

7. Focus on investments offering sustainable cash flow

This is very important. There’s been lots of investments over the decades that have been sold on false promises of high returns or low risk (for example, many technological stocks in the 1990s, resources stocks periodically and the sub-prime asset-back securities of last decade). If it looks dodgy, hard to understand or has to be based on obscure valuation measures to stack up, then it’s best to stay away. There is no such thing as a free lunch in investing – if an investment looks too good to be true in terms of the return and risk on offer, then it probably is. By contrast, assets that generate sustainable cash flows (profits, rents, interest payments) and don't rely on excessive gearing or financial engineering are more likely to deliver.

Final thoughts

Investing is not easy and given the psychological traps that we are all susceptible to – in particular the tendency to over-react to the current state of investment markets – a good approach is to simply seek the advice of a coach such as a financial adviser.

Dr Shane Oliver, head of investment strategy and economics and chief economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.