Get There More Quickly In The Slow Lane

There has been a significant amount of research done into traffic management which shows that reducing the average speed of vehicles on busy motorways, through speed controls, actually increases the flow of traffic and reduces the frequency and severity of traffic jams. Many of us have, at one time or another, decided to keep changing lanes when the one we are in seems to be moving forward more slowly than the others, only to find that the old man driving the Morris Minor in the inside lane that we passed an hour ago is now actually in front of us.

Investment is actually very similar to traffic management.

Having the discipline to stay in the inside lane on a motorway and not being tempted to chop and change as the traffic speeds up and slows down in other lanes will usually get you where you want to go in the same or less time.  Likewise, a diversified investment portfolio will include at least some risky assets which rise and fall in value. 

When an asset class diverges from the agreed allocation by a meaningful amount (we suggest 10% of the allocation but the optimum figure depends on a number of factors), that is the time to sell some if it has risen or buy more if it has fallen.  A disciplined approach is likely to have a far more significant impact on the variation in investment returns than trying to time markets or select individual securities based on what is happening on a daily basis in investment markets.

There is a possibility that one might be killed or seriously injured in a road traffic accident, either as a driver or pedestrian.  Most individuals accept this risk as one worth taking to get to their destination.  However, the risk can be lowered if the vehicle is well serviced, the speed of the vehicle is low and the driver is alert and aware. Investment returns have associated risks also which vary depending on the level of expected return. 

The higher the expected return, the more volatility (fluctuation in value) the investment is likely to exhibit.  However, over the long term (20 years or more) investors are rewarded for this uncertainty.  The investor's return is effectively the cost of capital of the companies in which they invest.  Without risk or uncertainty the likely return cannot be higher than that from risk-free assets like short term government securities or nobody would have any reason to provide capital to companies and capitalism would collapse. 

So next time you think about how you invest your money, ask yourself whether you are relaxed and being smart by staying in the inside lane and maximising your chances of investment success.  Or are you getting stressed out weaving all over the place and letting events you cannot control blow you off course?  Remember that traffic management research: by slowing down the average vehicle speed, the traffic flows quicker and more smoothly.  Let your investments do the same and avoid all the noise and waffle - you'll get where you want to go more quickly and you'll worry a whole lot less.

This article was taken from the Bloomsbury Financial Planning eBulletin 8 August 2007.