I love it when Vanguard updates their long term index chart (which can be viewed here: 2021 Vanguard Index Chart) which shows the compounding investment returns of shares, bonds, listed property and cash over the last 30 years to 30 June 2021. The benefits of remaining invested over the long term are clear: if you had invested $10,000 in 1991 into Australian shares it would be worth over $160,000 today, or you would have achieved an annualised return of 9.7% on your initial investment.
Everyone has their own view and experience of what investing means. Certainly, volatile times can make for volatile asset prices – such as we have seen at times during the pandemic. But real investment considered with a long-term time horizon, should not be exciting. As the Nobel Prize winning economist Paul Samuelson once said, ‘Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas’. And more recently, when Dan Kemp, Global Chief Investment Officer at Morningstar Investment Management, was discussing the rise and volatility of cryptocurrency in June earlier this year (Considering Crypto) ‘Remember that investing is really very boring. It’s about making long-term decisions based on valuation and spreading your risk, and that never changes.’
Investing in a single asset or company always involves some risk and speculation, due to uncontrollable factors which may impact on a single asset’s value and price. While investing in individual companies may be exciting and even thrilling at times as you watch the share price go up and down, it can also be time consuming and risky. Even for professional investment managers and research houses that spend countless hours analysing markets and companies against the backdrop of the economies in which they operate – there will always be unforeseen factors and change which can impact on the value and price of an asset. Such change may be positive or negative. Companies may change strategy and direction, competitors may increase or decrease, industries may excel or fall, economies may stall – there are countless uncontrollable factors that may impact on the success or failure of a single company and it’s share price. That’s where diversification comes in.
Investing in a diversified investment portfolio spreads the risk of a bad egg across more than one asset (and hopefully asset sectors), thereby significantly reducing investment risk. However, even a diversified portfolio (made up of say 30 assets across a particular asset sector) can often involve too much risk and speculation. And when an active manager or broker is charging for the service, it’s no wonder that on an after-fee basis, many investors are left far behind the index return.
Evidence shows that a globally diversified, liquid, index-based investment strategy is the most likely method of achieving preferred risk adjusted returns.
An index is a measure of a basket of securities which represents a certain asset sector or area within an asset sector, such as the Australian share market. The ‘ASX 300’ is the index which measures the returns of the top 300 companies listed on the Australian Stock Exchange weighted by market capitalisation. Why pay more to invest in 30 assets when it is possible to invest in 300 at a much lower cost via an index fund? Today, it is extremely difficult for an active investment manager to achieve preferential returns on an after fees basis to an index over the long term. And near impossible on a risk adjusted basis. Often, in order to beat an index after fees, increased risk is taken on, of which investors are often not aware. Until the bottom falls out of the investments. At which time it may be too late.
Of course, an index can also be subject to volatility. The Australian share-market for example, can be subject to severe and at times long-term corrections and fluctuations. When the impact of Covid-19 first struck our shores last year the share market fell by around 30% within weeks (and then recovered within 14 months and has continued to rise). However, adequate diversification of an investment portfolio across different asset sectors can assist to manage investment risk, at least in line with an investor’s risk tolerance. Taking a long -term view (to be able to see through the bumps along the way) when investing in growth assets is also of great importance.
Investing across asset sectors, according to your risk profile using globally diversified index funds is usually the best investment strategy. And usually best developed with an independent financial adviser. Accompanied with a true understanding of the risk/return factors associated with each asset sector invested in, should provide an unremarkable journey which gets you to where you need to be and allows you to stay there once you have arrived. It may not be thrilling – but there are other ways to get your adrenalin pumping. It should never be your investments.
Note that nothing in this article constitutes personal financial advice. The comments are general in nature and do not take into account the reader’s objectives, financial situation or needs. You should consider your own personal circumstances and seek personal financial advice prior to making any investment decision and make sure you obtain and read the relevant product disclosure statement(s).
 Assumes income is reinvested.