Let’s not kid ourselves, investment markets are chaotic, noisy and self-centred – just like children.
Over the long term, though, markets settle down into pattern-like behaviour that rewards the patient investor in proportion to risk. (Disclaimer: this argument cannot be applied to children under 18.)
Of course, in the midst of a market hissy-fit it’s a little more difficult to remember that this will all be worth it one day. And, for the first time in many years, markets are testing investor tolerance in 2018 with a series of public tantrums.
In February, for example, just about all types of assets were in the red, according to the latest monthly investment report from consultancy firm, Aon. Most significantly, the Aon survey showed the international share index was down almost 2 per cent for the month.
But it’s not just share markets throwing a wobbly. Global bond markets were down over both the monthly and quarterly periods ending February 28, the Aon report shows.
NZ-based assets covering cash, bonds and shares did turn in a positive performance in the month of February. As an interesting aside, though, the upbeat NZ equities result was due entirely to just one stock – a2 Milk – that recorded an astounding 50 per cent price rise over the month.
“Without the benefit of a2’s strong performance, the return of the NZ index for February would have been close to -4%, broadly in line with other major equity markets,” the Aon survey says.
Whether the current market ructions signal the beginning of a major downturn or merely the return to ‘normal’ volatility is a question forecasters get paid a fortune not to answer conclusively.
For most investors, too, the debate is futile: very few, if any, investors can perfectly time markets in a repeatable way.
However, the turbulent start to 2018 is a timely reminder for investors to ensure their portfolios are fit-for-purpose – and perhaps even to review that purpose.
Investment goals vary from person-to-person and change over time. There are many online tools now available to help determine what kind of investor you are – the so-called ‘risk profile’ – including the popular Sorted ‘Investor Kickstarter’.
Or you could seek professional financial advice.
Risk-profiling takes account of a number of individual factors such as age, investment time horizon (ie when you want to turn it into cash) and the current state of your assets. Most risk-profiling tools also attempt to estimate an investor’s psychological ability to handle market volatility – it may all be in your mind.
The risk-profile serves as a template for constructing the foundations of a real portfolio that matches your needs and personality. Risk-profiling suggests what kinds of assets could meet your goals rather than the exact investment vehicle to take you there.
Asset allocation is usually considered more important in determining long-term portfolio returns than picking individual securities.
Broadly, asset allocation refers to the mix of a simple list of ingredients within your portfolio, namely: cash, fixed income (bonds), shares and, often but not always, property.
Going up the scale from cash to shares increases risk in a very specific sense (as opposed to a vague feeling of dread). Asset class risk is measured primarily by historical volatility: that is, how many times in the past the asset price has moved up or down and by how much.
Cash – mostly money in the bank – has the lowest historical volatility; bond prices tend to fluctuate more over time; and shares flit about wildly compared to other assets. Conversely, in the long term, shares should provide the highest return followed by bonds then cash – but don’t expect that relationship to hold at any particular time.
In practice, asset allocation can be more complex – broken down by country or region, for example, or including real assets such as property. But the basic division between cash, fixed income and equities will provide a pretty good indicator of where your portfolio sits on the risk spectrum.
The year-to-date has reminded everyone that there’s still a little kid inside investment markets; but don’t let the screaming upset your adult asset allocation.