Uncertainty in Investing is the Enemy - Not the Bank
I have noticed that when many Kiwis join the world of investing in bonds and shares, their aim is to achieve a return that 'beats the bank'. Using bank deposits as your performance yardstick in this way arguably misses the whole point of investing. The bank is not the enemy, uncertainty is.
People who invest their capital in a wide range of assets that together form a diversified portfolio do so for one reason, and its not to 'beat the bank'.
The goal is to protect themselves against uncertainty and risk. Nobody knows when or where the next financial crisis or dramatic shift in markets or economic fortunes will happen. The vast weight of research to date shows that investing a portfolio across a diversified range of assets is the best way to mitigate risk, generate an income and to protect and grow capital over the longer term.
One stark lesson I have seen over the 20 years I have been in the investment sector is that uncertainty and risk can come from anywhere. Even investments that 'look safe' can get caught out.
The dramatic impact that the sharp decline in interest rates this year has had on short-term deposits is a classic example. Deposits are a low risk investment for sure, but for anyone that had all their capital invested in short-term deposits when interest rates fell from over 8% to just over 2% suffered a 75% decline in income, in a matter of months.If that's not disastrous enough, over the past six months they have seen consumer price inflation rise 2% (goodbye interest return!) and house and shares prices inflate by 25% or more. In other words, this cash just lost 25% of its spending power in the housing and equity market.
Certainly, when you have money invested in shares and bonds there will be times when your portfolio underperforms bank deposits, market volatility is part of investing. If you don't want volatility that's fine, buy bank deposits, but you need to recognise this is not as safe as it seems - see the previous two paragraphs.
Certainly, investing involves risk. As soon as you invest into financial and asset markets such as bonds, shares and property, you are exposed to risk.For example, from October 2007 to March 2009 the New Zealand equity market fell 41% in the wake of the recession and global financial crisis.
If you held a portfolio of New Zealand shares it probably fell by a similar margin, perhaps a bit less if it was made up of blue chips, or a bit more if it was mainly smaller or riskier stocks. The point is; if the market falls, your portfolio will fall with it. Over this period, 94% of NZ stocks fell in value. That's a very strong tide to swim against.
Being diversified into other markets didn't help either with over 90% of global share markets fell in value over this period. The very few exceptions included 'heavy-weight' markets like Ghana, Tunisia, Jordan and Bangladesh.
It is clear then that during this tumultuous 17-month period, if you were invested in shares, there simply was nowhere to hide.
But since March 2009 the reverse has happened. Our market has rebounded by 30% and most other markets around the world have risen by a similar, or larger, amount. Almost every investor in shares should have seen their portfolios rise by 15% to 20% or more over this period as they hitched a ride with the market. In the bad times we can blame the market, in the good times it's hats off to the market.
As the past couple of years have shown, investing is challenging. This is precisely why most people take a balanced approach to their portfolios; combining some low risk investments with some higher risk shares and property.
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