It can be difficult to pass on advice about money to the next generation. After all, things change and the world is likely to be a very different place in 30 or 40 years to that which it is today. However, here are three money lessons that could prove relevant in that time frame and beyond.
Don’t follow the herd
Whatever the asset, whatever the outlook, it is crucial to not follow the herd. This means that when demand for an asset is high and its valuation has increased dramatically, it is often the worst possible time to buy. That’s because a rosy future has been priced in. Should it disappoint, the asset’s value could tumble dramatically.
An example of such an event is the dot.com bubble. Technology stocks were exceptionally highly rated because of investor excitement at the age of the internet. While the internet has changed all of our lives, it has perhaps been less dramatic and slower paced change than was previously anticipated. Therefore, those technology stocks which increased in value at the turn of the century proved to be a poor investment.
Similarly, selling shares when the outlook is downbeat can also prove to be a bad move. The credit crunch is a prime example of this. Stock markets across the globe tumbled in 2008 and 2009 before recovering strongly in the subsequent years. However, many investors missed out on this rise because the general feeling among the investment community was one of fear.
Focus on more than profitability
For many investors, the key focus is on a company’s profitability. While that’s undoubtedly important, the reality is that there is more to a company’s financial health than just profitability.
For example, a company’s balance sheet strength will have a major impact on its long term financial performance. If it has high debt levels then profit may be sky-high, but most of it may end up being used to service interest payments. Similarly, weak cash flow which pays an overly generous dividend or has onerous capital expenditure commitments could mean that a company’s long term sustainability is compromised.
By concentrating on a company’s financial performance as a whole, rather than just on profitability, an investor can obtain a more accurate assessment of its overall risk profile. This should boost portfolio returns in the long run.
Seek out a competitive advantage
The companies that last over the long run tend to have a competitive advantage over their peers. This could be in the form of a lower cost base in the resources industry for example, or from a high degree of customer loyalty which has allowed them to charge higher prices than rivals.
Both of these examples will mean that the company in question has a higher chance of surviving difficult periods for the wider industry. They also mean that during the ‘boom’ years, their profitability will be higher which may lead to improved share price performance.
