You may remember the 80s – it was a decade of big hair, big phones, big pants and big hits (here’s a personal favourite).
It was also a decade of one of the biggest stock market crashes in history. But even with October ’87 in mind, the 80s wasn’t actually a period of big risk taking for the average investor, or more accurately, an investor seeking an ‘average’ rate of return.
Global research house, Callan, have recently completed a long-term study on the level of risk required in portfolios across different time periods to achieve a series of specific investment returns.
In a nutshell, their findings are fascinating – and full of implications for investors today.
Callan researchers found that investors seeking a return of 7.5% today need to take on almost six times more risk than they did 30 years ago to achieve the same return. Of course, the 80s were a different time, with higher interest rates and higher inflation, so that shouldn’t come as a surprise, right? Well, let’s strip out the effect of inflation and look at inflation-plus rates of return – and the result is that today’s investor needs to take-on roughly 2.5 times more risk to achieve a real return of 5%.
The key factor driving this outcome for investors is global competition and the speed of information in modern markets. Basically, it’s getting more and more difficult for even the most brilliant investment analyst to uncover price arbitrage opportunities, mispricing opportunities or information asymmetries of any kind – at least in public markets.
So how should investors invest today?
Understand why you’re investing
We encourage investors to maintain a long-term view, but also to be clear on why are you investing and what are you hoping to achieve? Be specific (when I say ‘specific’ it is almost certain that I mean ‘more specific than you are thinking’) and structure your portfolio around these goals – ensure you are taking investment risk in only that portion of your portfolio that can afford it.
Understand what you’re investing in
If you can’t explain it – you don’t understand it. It is vital to only take on risks you understand and accept. A good place to start is to understand what you are currently exposed to – what is the risk and expected return trade-off that you are currently exposed to? You definitely need to accept investment risk if you are seeking more than the cash rate, but some risks are better than others (as they say).
Reassess your strategy
Take a hard look at your investment strategy and the role of asset classes within your portfolios. Are your portfolios diversified and risk aware? Or are you running the same ‘balanced’ portfolio you’ve always maintained? Where is your growth potential – the ASX? Property? Illiquid or private markets? Is your portfolio able to deal with and potentially leverage upcoming market volatility? Do you have sufficient liquidity to fund planned liabilities and to take advantage of any upcoming buying opportunities?
Consider a partnership
When it comes to investing, unfortunately it’s not just money for nothing. Striking the right balance between achieving returns and limiting your exposure to the risk of losses is tough, let alone keeping on top of market research and understanding the emotional and behavioural aspects of investing. Having someone work alongside you, providing input and insight while taking emotion out of the equation, could be beneficial. If you would like to discuss any of the above, or would just appreciate a fresh set of eyes on your current financial approach, get in touch with us.
Disclaimer: This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.