Balance is something most of us aspire to in many parts of our life – be it work/family time, diet or exercise.
The past 20 years have taught us that a balanced approach to investing can help navigate some of the more turbulent times that can confront investors.
Balance is one of Vanguard’s core investment principles and it speaks to the need for investors to understand the value of taking a balanced approach to their asset allocation decision.
As Vanguard marks 20 years of operating in Australia, we have taken the opportunity to look back on the past 20 years to test how well our core investment principles – goals, balance, costs and discipline – have stood the test of time.
There is a strong body of research (including the 2012 Vanguard paper, The global case for strategic asset allocation) that has found over the years that the most important decision any investor makes is setting their asset allocation.
The challenge that comes with that is it is almost impossible to select the asset class that is going to be next year’s winner. Or the year after that and the one after that…
When you look back over the past 20 years and plot the performance of all the major asset classes from domestic and international shares, domestic and international fixed income, domestic and global property and emerging sharemarkets there is no discernible pattern.
It certainly adds weight to the argument that past performance is not a reliable indicator of future performance. Indeed, when you plot the various asset classes in different colour squares it looks more like a random patchwork quilt than a tool for making investment decisions.
This is not to say investment markets have not rewarded investors over the past two decades.
If you had invested $10,000 in Australian shares 20 years ago, it would have grown to around $51,480 by 2016. A conservative Australian fixed income portfolio would have grown more sedately but with a much smoother ride to $37,6061.
International shares was the top performing asset class over the past two decades, and of course if you had known that 20 years ago, then you would have simply put all your money into international shares confident in the outcome.
Sadly, forecasting the future with any sort of accuracy remains a skill well beyond the reach of us mere mortals. Investors in international – and domestic – shares have had to endure a wild ride at times. Think the ‘Tech Wreck’ in 2000 that really hit the US market hard, or in more recent memory, the Global Financial Crisis (GFC) of 2008.
By comparison, investors in fixed income or cash have had a much smoother journey but they have also missed out on higher returns from other asset classes.
In the real world investors have to decide where on the risk spectrum – cash/fixed income being at the conservative end and shares at the higher risk end – they want to sit.
One of the lessons out of the review of the past 20 years is that risks and market shocks can and do appear from unforeseen sources – the US residential housing market in the case of the GFC. As investors, we should accept that market shocks will disrupt our best laid plans from time-to-time.
So understanding your tolerance for risk and market volatility is a key piece of information for investors when deciding their asset allocation. That can be easier said than done and is an area where working with a professional financial planner can help an investor get comfortable with the level of risk they want to take.
Setting an asset allocation is the first thing – sticking to it is another issue entirely.
Let us take the example of three investors who each had the same balanced portfolio (50 per cent growth assets and 50 per cent fixed income) back in 2008 before the GFC hit.
By February 2009 their respective portfolios had all fallen 18 per cent in value.
One investor decides it is all too much and switches the portfolio to cash to stop the losses.
The second investor is also worried about the dramatic decline in the value of the portfolio and opts to switch to a more defensive asset allocation and shifts the portfolio into fixed income.
The third investor – while concerned at the global market gyrations – decides to stick with the 50/50 asset allocation in their balanced fund.
It is not surprising that three quite different asset allocations results in quite different portfolio performances. If we move forward from February 2009 to February 2016 the investor who shifted to cash (and stayed there) has seen their portfolio value grow 27 per cent; the second investor who took the fixed income approach saw the portfolio grow a healthy 71 per cent.
The change-nothing investor that stayed the course with a 50/50 asset allocation saw their portfolio grow 93 per cent from the trough of the GFC to February 2016.
The asset allocation decision has been shown to drive about 90 per cent of a portfolio’s performance, but it is not a once-off static decision. The asset allocation for a 30-year-old, given their investment time horizon, may well be more aggressive with growth assets than a 60-year-old approaching retirement may feel comfortable with. And as the 30-year-old moves through different life stages the asset allocation can and should rebalance.
The lessons from the past 20 years is that we should expect different asset classes to regularly change positions on the annual performance rankings.
The investor’s quest is keeping the balance right between the various asset classes that will give you the best chance of reaching your individual investment goals.
1 Source: Andex Charts Pty Ltd
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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