Will share returns remain low?


Share and cash investment returns are unexciting

It feels like the Australian share market has been going up and down in about the same spot for the past six or seven years. Many are becoming disillusioned with shares as an investment class and are looking to “juice returns” with the various hybrid structures and private equity “opportunities” on offer to take advantage of the discontent.

Cash, in the form of term deposits, has also lost its lustre, with yields at record lows. It’s not surprising that in this environment the perennial favourite, direct investment into residential property, has become even more popular. The house price rises experienced over the past three or four years, particularly in Sydney and Melbourne, make the share market appear a pretty dull alternative.

This article examines some of the historical facts that underpin current feelings. While we don’t know what will happen in the future, the past suggests that current investment returns are not inconsistent with what investment theory would expect and may not be a good guide to future investment returns.

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Investment Yield versus Return for Risk

Investment Yield versus Return for Risk
What to do when cash rates fall?

With interest rates on cash in Australia falling to record lows, in absolute terms, there seems to be a scramble by investors to chase higher returns for their capital. Cash, which often ends up as the investment of choice by default, seems no longer a palatable option, with cash rates at a level that is now causing significant pain for many investors.

With cash rates so low there are numerous alternatives that offer a higher income return, or yield, than cash. For example, Australian Bank shares offer investors a grossed up dividend yield of close to 7.0% per annum – that’s a significant uplift on the Reserve Bank ‘s 2.25% per annum cash rate. This appears as an appealing alternative to investors who can no longer stomach the opportunity cost of holding cash.

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“wealthcheck” for early career professionals

wealthcheck for early career professionals
By your late 30’s, your decisions may have significantly shaped your financial future

In a previous article, “ ‘wealthcheck’ and retirement preparedness”, we used the “wealthcheck” framework to compare the financial vulnerability of two, apparently similarly placed, pre-retirees. We also claimed that the framework was just as applicable to assessing the financial soundness of early accumulators.

To demonstrate, this article compares the situation of two (fictitious) couples, the Blacks and the Whites, who are both successful young professionals and 27 years away from their nominated retirements. While retirement seems a long way off, the “wealthcheck” framework reveals that financial decisions made at this stage of life can significantly limit future financial flexibility and, perhaps, make you unnecessarily vulnerable to financial disappointment.

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Don’t put all your investment eggs in one basket

Dont put all your investment eggs in one basket

Concentrated investments add to risk but have no expected extra return

Our previous article in our series on the Personal Financial Dashboard – a graphic format that succinctly captures the journey to, arrival at and maintenance of financial independence – examined the rationale for setting a target maximum growth asset allocation. And, as a corollary, a minimum defensive asset allocation.

This article looks more closely at an aspect of how both growth and defensive assets should be held in order to increase the chances of both becoming and remaining financially independent. It is the focus of Chart 6 of the Personal Financial Dashboard, the Diversification Ratio.

When you are relying entirely on your investment wealth to finance your desired lifestyle for an indefinite period, it’s generally not the time to take more investment risk than you need. While you may wish and require your wealth to grow, effective wealth management should largely be about ensuring that in the quest for higher returns unnecessary risk is avoided.

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How much investment risk can you bear?

How much investment risk can you bear?
Your allocation to growth assets is a key measure of investment risk

In our previous article in our series on the Personal Financial Dashboard – a graphic format that succinctly captures the journey to, arrival at and maintenance of financial independence – we discussed the need to be tax aware when investing. Financial independence is harder to achieve if there is an unnecessarily large tax leakage.

But tax shouldn’t be the overriding factor when making investment decisions. Rather, the primary focus should be on risk and related return. The Personal Financial Dashboard includes two charts which look at key aspects of investment risk management i.e.:

  1.  the Growth  Asset Allocation Ratio (Chart 5); and
  2. the Diversification Ratio (Chart 6).

In this article we focus on the Growth Asset Allocation Ratio (“GAAR”). The Diversification Ratio is discussed in our next article.

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Should your feelings influence investment decisions?

Should your feelings influence investment decisions?Our feelings aren’t reliable indicators of future investment returns

If you let it, investing can be an emotional roller coaster. But while in many walks of life how we feel may be an important input to decision making, letting short term emotions substitute for a soundly constructed long term investment strategy is generally not a good idea.

For example, the emotions of fear and greed, allowed to run unchecked, can drive behaviours that are deleterious to our financial health. Evidence shows we often rush to sell when share (and property) markets are at their gloomiest (with prices relatively low) and fall over ourselves to buy when asset prices have risen and are relatively high. Consistently selling low and buying high is a sure fire way to go broke.

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The Great Dividend Yield Chase

The Great Dividend Yield ChaseHigh dividend paying shares appeal to many investors

It’s often suggested by various investment “experts” that the first requirement for a share investment is income return and then growth of capital. This implies that income return is a key driver of investment performance. Perhaps it explains why so many investors are so focused on income yield when choosing a share investment.

While we don’t know conclusively why investors have a preference for dividends over capital growth, some of the reasons we’ve heard include:
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Portfolio Diversification versus Portfolio Insurance

Portfolio Diversification versus Portfolio InsuranceHow can I protect against a loss of investment capital?

Since the GFC there’s been a lot of talk about ways to protect investment portfolios from the types of falls experienced in late 2008. There are two ways to overcome this risk: portfolio diversification or portfolio insurance (or hedging). We’ve compared the two in this article.

Portfolio diversification involves the practice of combining investments with low correlation to reduce the overall volatility of the portfolio. This invariably means holding some “losers” amongst your “winners”; a practice that often doesn’t sit well with a “winner’s” mindset.

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Revisiting the Global Financial Crisis

Revisiting the Global Financial CrisisHow did you feel during the depths of the GFC?

With the benefit of time, we tend to forget the strength of emotions we experienced in the past. I recently came across an email that we sent to a couple who were struggling with the uncertainty created by the Global Financial Crisis . It was written on 19th February 2009 – a couple of weeks before world share markets bottomed.

The email is a good reminder of the heightened emotions that prevailed at the time and the irrationality that they can produce. The couple were imagining all kinds of catastrophes and looking for any other solution than patiently sitting things out. Investor sentiment at the time was pretty low, with pessimists outranking optimists by seven to one.

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The Reality of Lifetime Annuities in Australia

The Reality of Lifetime Annuities in AustraliaLifetime Annuities: good product, immature market

If you’re looking for a way to outsource your investment, longevity and inflation risks, you’re in luck. There is a financial product (a lifetime (indexed) annuity) that allows you to achieve this aim. However, the market for these products in Australia is quite immature, which is not good news for purchasers.

The lifetime annuity market in Australia has been around for many years, yet its size has never been significant. In 2001, 1,927 lifetime annuities were sold for a total value of $166 million. By 2004, this had increased to 2,801 annuities worth $281 million.

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