In an earlier article we looked at asset allocation – that the manner in which you allocate your assets across cash, fixed interest, property and shares will be a critical determinant of the long-term investment performance of your investments.
How critical? Studies conducted on the performance of managed funds suggest that as much as 90% of your investment returns will be explained by the asset allocation mix, and only 10% by the choice of individual investments (which is where the average investor spends their investigation time).
The decision of what asset allocation mix is appropriate for you is important but not necessarily straightforward. With the potential for greater returns comes the potential for greater risk and volatility.
It’s worth having another look at the difference the asset allocation choice can make to your investment outcome.
An investor investing $300 per fortnight for 20 years and consistently earning 5% after tax and fees would expect to accumulate $267,600.
Investing with a more growth orientated asset allocation, which returns 7% after tax and fees, would grow $300 per fortnight to $339,600 - that’s an increase of $72,000, which in any one's language is a substantial difference.
If you have just retired and have a lump sum to invest the message is exactly the same - how long your funds will last will depend on the return you earn over your retirement. Your asset allocation choice is likely to be more conservative, however.
Higher return does carry with it some issues. The first will be that the higher the projected return the more volatile returns on a year-by-year basis will be.
An asset allocation targeting 7% might have a negative return as often as every 3 years and the returns might vary between as much as –25% and +45%. That is volatility in any one’s language.
And what will happen in the midst of all that volatility. At some point along the way it is likely that the investor will jump ship unless they have patience and a good understanding of how markets work.
And having felt that they have been burned their investment strategy is likely to become more defensive – and that could cost a considerable number of lost dollars over the years as seen by the $72,000 example above.
The asset allocation choice is crucial. And because it is so important, we will be talking to you about it occasionally just to make sure that we have you on the right place on the risk and return scale.
