Which asset class will provide the best returns in the next 12 months? Property, shares, bonds or cash?

By September 23, 2016Financial Planning

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“The trouble with the world is that the stupid are cocksure and the intelligent are full of doubt.” Bertrand Russell

 

Many clients that I meet often struggle to work out where to invest their money. Do they invest in property? Or has property already peaked? What about the share market? Do they have the stomach for the high level of volatility? With low interest rates, cash and bonds are relatively secure but the returns are very low too. So what do they do?

When a decision is perceived as difficult, research shows that most humans choose to avoid making one (i.e. procrastination).

The aim of this short blog below is to demonstrate that the decision of where to invest your money is actually quite simple if you make friends with one truth. That is, that no one knows what’s going to happen next – including financial professionals! Let me explain.

Historical trends tell us…

The saying goes that “history leaves clues”. I have compiled a chart that compares the returns from various major asset classes over the past 23 years including Melbourne property (i.e. beginning Jan 1993 through to Dec 2015). Click here (for the most up-to-date table) or the image below to enlarge this table.Asset class returns The table looks a bit messy so let me explain. All the returns are colour-coded (e.g. green is international shares) and each year is sorted by return with the highest return at the top of each year.

Do you see any patterns?

The answer is no. There are no patterns at all. Returns are completely random (as Burton Malkiel wrote in his classic book, A Random Walk Down Wall Street). And no one has developed a reliably consistent way of predicting returns in the short term.

The answer is that no one really knows and the “experts” are actually wrong more often

The internet and newspapers are full of predictions, forecasts and analysis. But they are all of very little use. The largest and longest study (as noted in the book “The Elements of Investing”) of expert predictions was by Philip Tetlock, a professor at the Haas Business School of the University of California-Berkeley. He studied 82,000 predictions over 25 years by 300 selected experts. Tetlock concluded that these predictions barely beat random guesses. Ironically, the more famous the expert, the less accurate his or her predictions tended to be.

Therefore, when working out where to invest your monies, you must adopt one very important assumption: no one (including you and your advisor) can predict short term returns.

There are three things you have to do as a result of this key assumption

1. Always think long term (i.e. greater than 10 years)

Making long term financial decisions typically provides two benefits. Firstly, long term decisions nearly always yield the best results. As Howard Schultz (Starbuck’s fame) says “short term profit does not create long term value for everyone”. And Warren Buffett says, “the stock market has a very efficient way of transferring wealth from the impatient to the patient”. Quality investment assets require two ingredients to perform, time and patience.

Secondly, thinking long term reduces the anxiety created by worrying about short term market movements. For example, if I buy a 2-bed art-deco apartment in South Yarra (Melbourne) for $700k with the view that it has an excellent chance of being worth over $5 million in 30 years (i.e. just less than 7% p.a. growth), do I care what happens to prices next year? No way.

2. Many eggs in many baskets

The role of a smart asset allocation (i.e. how your money is divided up amongst various asset classes), is (1) to avoid losing money and (2) reduce volatility. The theory is that if your assets are spread across variable assets, then on any one year, some assets will make money and some will lose money and some will break even (do nothing) – as historically illustrated above. On the whole however, you hope to make money each year (i.e. any losses are offset by higher profits/gains).

The main asset classes include direct property, shares, bonds, cash, commodities, gold and ‘alternatives’ (e.g. infrastructure, private equity, etc.).

The asset allocation that is appropriate for you depends on your goals, your current investments, surplus income, your risk profile and your investment time horizon (stage of life). If you are to seek professional advice on just one thing, get asset allocation advice. Arguably, it’s an investors’ most important decision.

3. Quality is key

All markets will exhibit volatility from time to time – often created by irrational investor behaviour (either overly optimistic or overly pessimistic). However, in the fullness of time, fundamentals will ultimately determine the long term investment outcomes. Therefore, the best way to maximise long term returns it to focus on asset quality. Asset returns will be commensurate with asset quality. That is, a high quality asset will produce high quality returns in the long run. Therefore, as an investor, if you are going to be preoccupied with one thing it should be to only invest in the highest quality assets you can afford. The rest will look after itself.

Relax and invest

Once you realise that you don’t need to worry about short term market movements you will feel a lot more comfortable and confident about investing. You can ignore all the media noise and never-ending scare mongering and focus on the things that really matter (i.e. the three things discussed above). If you would like help with developing your asset allocation and investment strategy, you might like to consider our Wealth Coach service here.