Let’s start by defining what an Investor is?
According to www.BusinessDictionary.com
“An Investor Is neither a speculator (who takes on high risks for high rewards) nor a gambler (who takes on the risk of total loss for out of proportion rewards), but one whose primary objectives are preservation of the original investment (the principal), a steady income, and capital appreciation.”
All I would add to this is the purpose (objective) for the investment which quantifies and times the whole process.
So removing the speculators and the gamblers from the equation, will an investor benefit by taking acceptable risk over a period of time?
It is commonly accepted within all sectors of investment management that the more risk you take, the higher return you should expect.
Investment risk has many interpretations but for the sake of simplicity let’s say that it represents volatility of invested capital and returns. This obviously means there is a chance of reduction or loss of capital.
As a measure of return for the lowest possible risk of an investment product, we utilise a bank term deposit.
In current markets, we know that we may be able to lock-in a term deposit with the bank at 7.15% p.a. interest rate for a period of 5 years (RaboBank). This is our starting point.
An investor should therefore expect to gain some additional reward (return) if they are looking to invest their money, for the same period at a higher level of risk.
What are the investment options?
For the sake of this exercise we will not include residential property as an investment product. We are fully aware that for most of our clients the residential property market represents a significant portion of their wealth, and in fact has been the most prolific performer over the past 5 to 10 years. We will also not include cash (short term bank savings) as Investors should not be holding more than 5% in this asset unless it’s for a specific short term funding requirement.
Moving up the risk scale and staying within the conventional asset classes (please note that these investments can be held directly or via fund managers as well as locally or internationally) this is the acceptable order of increasing risk and expected higher return. It is also important to note that the longer the investments are held in selected assets, the more apparent the trend should be. Generally, long term investing is accepted to be 5 years or more (with (1) being least risky and (5) being most risky).
| Asset Class |
| Term Deposits (1) |
| Australian Bonds (2) |
| Listed Property (3) |
| Australian Shares (4) |
| International Shares (5) |
So, what do the statistics tell us?
These are the facts for the last 10 (calendar) years to 31.12.2010
| Asset Class | Rate of Return % | Rate of Return % (2008) |
| Term Deposits (1yr rate) | 4.9 | 5 |
| Australian Bonds | 5.8 | 15 |
| Australian Property (listed) | 2.4 | -54 |
| Australian Shares | 8.7 | -40 |
| International Shares | -4.0 | -25 |
| Balanced Funds | 4.9 | -22 |
In order to achieve stability and reduced volatility (risk) most investors will diversify their funds across the range of assets. For this reason I have included the most popular diversified investment fund, the balanced fund. Such funds typically hold 70% in Growth investments and 30% in Defensive investments.
One other factor worth noting is that short term volatility (risk) can be quite extreme as highlighted by The Global Financial Crises (2008).
Clearly these statistics will change and sometimes dramatically over any given period. However, even looking over the past 20 years the pattern is not too dissimilar, in that, the highest return has been gained in the Australian shares and the lowest in the International shares.
Theoretically this should not happen. International shares add another level of risk, (including currency) and provide a greater level of diversification; they should be on top of the performance chart. Sadly enough, for most fund managers, the ‘Balanced Fund’ has underperformed both fixed interest and even cash for most of these investment periods.
Given the relatively modest performance of recognized asset classes over time, the significance of the management fees charged by superannuation and investment funds speaks for itself.
Typically, a ‘Balanced Fund’ will charge anywhere between 1% to 3% p.a.
Back to our original question – is risk worth it?
Will taking investment (market) risk reward you with higher investment returns?
There are two scenarios;
1) If you are a wealth accumulator, constantly investing in your portfolio, with a relatively modest balance and a long term time horizon (20 years +).
Diversified risk should reward you with gains above cash and term deposit rates. Be prepared for a bumpy ride and stick with your long term strategy investing in high and low markets. Be aware of the fees and taxes and try to always reduce them to the minimum. Calculations have shown that even 1% increase in fees can result in 20% reduction in value of your retirement savings.
2) If you are within 10 years or less of your intended retirement or some other targeted date for your savings,
Your primary objective should be the protection of, and access to your capital. If you are looking to retirement, than a regular and secure income – which won’t be impacted by market movements and will last for as long as you do and beyond – is far more important than a chance of outperforming the markets.
Even one year of negative returns (refer 2008) can cause irreparable damage to your long term retirement plans. Just bare in mind that a 50% loss to your accumulated savings requires a 100% return to bring you back to even.
We do not speculate or gamble with our clients’ money, and therefore we are most selective of the risk we take and why we take it. Yes, some risk is worth taking, but you must have clear purpose for doing so and modest expectations of rewards over a given time.
RETIREMENT PLANNING SEMINAR
Gisborne Golf Club – Club Rooms
Wednesday the 27th April @ 6.30pm
Please book by calling: 03 9337 2233