Is your investment risk strategy paying off?

Is your investment risk strategy paying off?Are you an intelligent risk taker?

Most investors accept the notion that risk and return are related and that those who are prepared to take on more risk will ultimately get rewarded for their risk taking. As we’ve seen with the implosion of some investments during the GFC, increased risk taking does not always guarantee higher returns, it simply exposes you to the opportunity for higher returns.
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Should past performance affect your willingness to take investment risk?

Past investment performance is seductiveShould past performance affect your willingness to take investment risk?

It’s a difficult task being a good investor. You’re keen to celebrate when your investments perform well, yet you’re also looking for opportunities to acquire new exposure when prices are low. Unfortunately, good investment performance and low prices rarely go hand in hand. This creates an ongoing dilemma for wealth accumulators – do you want your investments to go up or down in the short term?

Many investors are reluctant to invest new money in asset classes that show poor recent performance, instead preferring to increase their exposure to the better performing asset classes. This seems to be a logical thought process, but is it conducive to the achievement of your wealth accumulation plans?
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Taxes, investment costs and investment returns

Taxes, investment costs and investment returns High before tax returns may not be best …

If you accept the often repeated warning that past investment returns do not provide a guide to future performance, you would be smart enough to not select a fund manager based simply on their recent results.

But what if you knew for certain (which you couldn’t) that a particular investment manager would return 1% p.a. above their relevant market indicator, before investment costs and taxes, for the next 10 years. Would you select that manager in preference to one that guaranteed you the market return? As we demonstrate, not necessarily.

Your objective as an investor should be to maximise your investment returns after-tax, costs and inflation for the amount of risk you accept i.e. your net risk adjusted return. In this article, we will focus on the importance of taxes and investment costs (e.g. fund manager fees, transaction costs). We have discussed the risk issue extensively in our “Foundations of Financial Economics” articles and, excluding inflation indexed bonds, there is little an individual investor can do, directly, to take account of inflation.
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Understanding Investment Returns

Investment returns are often not what they first seem

There is often a lot of misguided talk, sometimes boasting, about the level of returns people get on their investments. This can leave some feeling as though they’ve missed out.

Before you get too caught up in what others are (apparently) achieving you need a good understanding of some important investment return concepts. You need to make sure you are comparing apples with apples and this is often very difficult to do.

We look at three fundamental issues that need to be considered when reviewing investment returns.

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Investment Return Volatility – A Potential Wealth Hazard

Volatility: a wealth hazardInvestment return volatility is poorly understood

Most investors understand that in order to increase their expected future return, they have to accept a higher level of volatility (or variability) in the value of their investment portfolios. But beyond that, they do not understand just how damaging volatility can be to their wealth aspirations.

The amount of volatility you expose yourself to affects your probability of achieving a desired wealth outcome. In this sense, it is a forward looking concept. And, as such, it is an extremely important factor to take into account when designing and managing any investment strategy.

But this article reveals some poorly understood aspects of volatility, by looking backwards. That even when you know actual returns and actual volatility, wealth outcomes may vary dramatically.
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Protected Equity Products: Can you have your cake and eat it?

Protected Equity Products: Can you have your cake and eat it?Loss protection and tax advantages …

Protected Equity Products (PEPs) are heavily marketed at this time of year.

They are promoted as an opportunity to benefit from share market growth, without the risk of losing capital. They involve borrowing up to 100% of the purchase price of a basket of shares for a minimum period (generally 3 – 5 years). You keep the dividends and any gains and are protected against investment loss.

The loan interest is also usually prepaid to bring forward a tax deduction and reduce a current year “tax problem”. What a deal – no downside and tax benefits!

However, even with this basic explanation, the alarm bells should ring for smart investors. PEPs play to at least one psychological bias (i.e. “loss aversion”) that investors should be wary of and contradict at least one of our wealth management decision making principles (i.e. “It’s about ends, not means”).
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Why have a Self Managed Super Fund?

Not for higher investment returns …Self managed super fund

There has been an above trend increase in the number of self managed super funds (“SMSF”) set up recently. Such spurts usually occur when investment returns have been poor. The expectation appears to be that better returns will be achieved with a self managed fund.

However, there is no clear link between investment performance and super fund structure i.e. self managed, industry, corporate or retail public offer. While industry fund advertisements suggest otherwise, their claims relate to the relatively higher costs of the alternatives. Before costs and taxes, no structure has any inherent investment performance advantage.

Five potential SMSF benefits …

But a SMSF offers at least five potential benefits over other super structures:
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Five Things To Remember In Difficult Times

“I have not looked at any of my holdings and don’t intend to. I don’t want to be tempted to jump because I think I’d be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section.”

Quotation attributed to Richard Thaler, professor of behavioral science and economics, University of Chicago Graduate School of Business.[1]

These are difficult times – nobody knows how and when markets will stabilise. We appreciate the emotions they arouse. But you should take some comfort  that our planning process is not driven by what is happening in the market at any point in time. It focuses on achieving your long term financial objectives, based on reasonable projections of long term investment returns.
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