Taking time to revisit the basics periodically is a practice we’ve always advocated for. When you’re living and breathing the markets day in and day out, it’s easy to lose sight of fundamental principles—sometimes you can’t see the forest for the trees. The beauty of the basics is that they often remain consistent over long periods, even while the world around them changes. Today, we want to take a moment to reflect on what we’d tell our 21-year-old selves about finances and achieving financial independence, focusing on several time-tested principles.
These concepts are not just independent rules but interconnected ideas that influence each other. The markets are complex, and while no principle can be applied in isolation, the basics are your building blocks. Once mastered, they can be expanded upon and made more intricate as your understanding deepens.
Principle 1: High Return = High Risk
At its core, the market is a function of risk, although recent years of unconventional monetary policy may have blurred this fact. Understanding risk and return is essential for any investor. The strongest portfolios are those that maximise expected returns while minimising risk. To illustrate, imagine two investments, A and B, with identical expected returns. The key to choosing between them lies in determining which carries the lower risk. But here’s the tricky part: investment is as much an art as it is a science, meaning that sometimes your decision will hinge on both quantitative analysis and your belief in the investment.
Risk is often manifested as volatility, and as investors, we must learn to live with it. Market fluctuations can be harsh—Charlie Munger famously noted that a 50% drawdown is the “price of admission.” But it’s important to keep perspective. Aside from rare events like the Great Depression, the markets have historically been generous over the long term. Volatility is best viewed through the lens of time. If your investment horizon is measured in decades rather than years, volatility becomes less concerning. The longer you stay invested, the more you can tolerate short-term fluctuations. This brings us to a critical mantra: time in the market beats timing the market.
Principle 2: The Rule of 72 and the Power of Compounding
It is rumoured that Albert Einstein called compound interest the “eighth wonder of the world,” and nowhere is this more evident than in the Rule of 72. This rule helps investors estimate how long it will take for their money to double based on a given rate of return. For example, with an annualised return of 7.2%, your money will double in ten years. It sounds simple, but understanding compounding through this lens encourages discipline and patience. There’s no need to rush—time does much of the heavy lifting for you.
Consider an example: $100,000 invested at 7.2% annually grows to $1.6 million over 40 years, without any additional contributions. Now imagine adding regular investments into the mix. The results become even more powerful. This strategy, known as dollar-cost averaging, not only helps you build wealth but also mitigates sequencing risk—the risk of poor returns during specific periods of time. Regular contributions, especially in volatile markets, help smooth out returns and reduce the emotional decision-making that often plagues investors during market swings.
For those with a higher risk appetite, consider a rules-based system. When the market experiences a drawdown, buy more shares incrementally. Conversely, reduce your purchases as markets rise. This approach aligns your investments with market sentiment, ensuring your strategy adjusts based on the level of fear or greed in the market.
Principle 3: Don’t Borrow What You Can’t Repay
Leverage can be one of the most powerful tools in investing, amplifying both returns and losses. Used correctly, debt can be productive—leveraging property investments or making strategic stock purchases can be wise moves. But debt for debt’s sake is dangerous. Always plan for worst-case scenarios. For instance, if you’re investing in property, ask yourself: what would happen if your rental income was halved or interest rates doubled? Prepare for the worst, even if the capital seems freely available.
For equity investors, leverage can be especially risky. Your ability to withstand margin calls often depends more on your emotional stability than on the actual numbers. If your first experience with leverage was positive, it might encourage risky behaviour. But if it was negative, you might become overly cautious, even when it’s not warranted. The lesson here is to only use leverage for a small portion of your portfolio and never borrow more than you can afford to lose. Plan as though your borrowed capital could go to zero, and invest accordingly.
Principle 4: Quit Procrastinating
Procrastination is one of the most common pitfalls for investors. With so much information available, it’s easy to fall into the trap of over analysing and delaying decisions. However, the markets will never offer perfect clarity. At some point, you must develop a view, take action, and be prepared to adapt if conditions change.
Waiting for the perfect moment can be just as harmful as making a rash decision. The overload of information—often conflicting—can lead to analysis paralysis. For instance, if you wanted to research every detail about a stock like Apple (NASDAQ: AAPL) before buying, you might never actually make the purchase. The sheer volume of available information makes this an impossible task. Don’t let perfection be the enemy of progress. Set your goals, understand your parameters, and, as Nike says, “just do it.”
Remember, even doing nothing is a decision. If you decide not to act, make sure it’s based on logic, not fear. And always challenge yourself: if you’re not investing, ask why. Pretend you’re explaining your reasoning to a room full of financial experts who will question every assumption you make. If you can’t justify your inaction, it’s time to reconsider.
Principle 5: Diversification is Vital
Diversification is one of the most powerful tools for managing both short-term volatility and long-term market risk. While full-time investors may afford a more concentrated portfolio, most people should diversify to spread their risk. Even the best companies can fail, as demonstrated by the likes of Kodak, which once dominated its industry but has since faded into obscurity.
The challenge with diversification is finding the right balance. As you add more investments, the marginal benefit decreases while costs increase. A portfolio of 15 to 30 investments or strategies is generally optimal, and older investors may prefer the higher end of that range. Diversification allows you to reduce the risk of any single investment having an outsized impact on your overall portfolio, ensuring that your long-term goals remain intact.
Principle 6: Ask Questions
Asking questions is fundamental, not just in investing, but in life. It’s how we learn and grow. Every time you consider a new investment, ask “why” until you’ve thoroughly explored every assumption. This relentless curiosity will make you a better investor.
And don’t be afraid to ask tough questions of your financial advisors or portfolio managers. After all, you’re the one with skin in the game. At AGMs, remind management that they are simply custodians of your capital. You’re the owner, and it’s your right to demand accountability.
Principle 7: Keep an Emergency Cash Fund
Australia is a fortunate country, but it also has one of the highest household debt levels in the developed world. Given today’s interest rate environment in Australia, leveraging debt might seem less appealing than it once was. However, with inflation still a concern, having an emergency fund is more crucial than ever for weathering unexpected financial storms.
As a rule of thumb, younger individuals should keep at least three months’ worth of living expenses in an emergency fund. This cash cushion ensures you’re not forced to sell investments at an inopportune time to cover unexpected costs.
Principle 8: Track Megatrends and Themes When Investing Long Term
This principle ties back to diversification. While you must remain diversified, it’s also important to stay nimble and adjust as new trends emerge. Megatrends, such as demographic shifts, artificial intelligence, and growing income inequality, will have profound effects on markets for decades to come.
For example, slower economic growth in Western countries and changing demographics will impact industries like healthcare and pensions. Meanwhile, advancements in artificial intelligence will disrupt sectors ranging from transportation to retail. However, picking winners in these trends is challenging. Instead of betting on a single company, look for those that provide key components to multiple players within an industry.
The key takeaway: understand how megatrends affect your portfolio and be prepared to adjust your investments accordingly.
Principle 9: Minimise Taxes
Finally, minimising taxes is an obvious but often overlooked principle. The less you pay in taxes, the more wealth you accumulate over time. In Australia, this can be as simple as placing capital growth assets within the superannuation environment or utilising franking credits.
However, tax considerations should never drive your investment decisions. Don’t hold onto an investment just to avoid paying capital gains tax. If a better opportunity arises, it’s worth paying the tax.
The TAMIM Takeaway
At TAMIM, we understand that investing is both a journey and an ongoing learning process. The principles we’ve revisited here—balancing risk and return, leveraging the power of compounding, maintaining diversification, and staying disciplined—are the foundational elements for long-term financial independence. Whether you’re an experienced investor or just starting, these concepts remain as relevant today as they were decades ago.
In particular, the importance of staying proactive cannot be overstated. Making consistent, thoughtful decisions and adapting to evolving market conditions is key to success. While the markets can be complex, staying focused on these tried-and-true basics will help you navigate uncertainty and take advantage of opportunities.