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Buckle up even when markets are good

Life would be so much simpler if investing was just about performance.

That point was driven home by an investor recently who declared he was selling all his fixed interest investments and putting 100% of the money into shares.


The reason? Performance of the sharemarket has been so strong for so long that he felt it no longer made sense to have money in fixed interest.

That is akin to saying you haven't had a car crash for the past five or six years so you no longer need to wear a seat belt. The whole point about wearing a seat belt is that you have it on to protect you against that unexpected crash.

The role of fixed interest in a portfolio is to help lower your risk but you can see why our investor was beguiled by the performance numbers: Vanguard's retail Australian share index fund that tracks the market performance has returned 23.8% (before fees) for one year to the end of February, 25.6% for three years and 16.3% for five years.

By contrast a diversified index bond fund for the same time periods has returned 4.8%, 6.1% and 7.1%. Solid numbers in a low inflation environment but hardly the sort of thing to get the blood pumping when double digit share market returns have become expected fare.

Look at the issue from the opposite perspective: if the sharemarket returns were -20% and the bond portfolio was +3% who would be lining up to sell all their fixed interest investments and be completely exposed to the risk of the sharemarket? This is the problem with using past performance to try and predict the future and why every financial planner and fund manager worth their salt will warn you of the risk of doing that.

For investors getting a good understanding of the risks they are taking within their portfolio can be difficult to get an accurate reading on. The key is to understand the potential volatility that is embedded in the different asset classes - be it shares, property or fixed interest.

If you want to earn a good return the tradeoff is you have to take some risk. The trick is to keep the risk factor firmly under your control. This is an issue that retirees in particular need to spend time understanding. When you are working and you lose money on an investment it hurts but time and the fact you can replenish your capital base at least is open as a road to recovery.

As a retiree if there is a major market crash and you lose 30 or 40 per cent of your capital that is virtually impossible to replace - unless you are fit enough to return to the workforce.

So at times like these it pays to remember why cars have safety belts and to think carefully about the role which fixed interest plays in your portfolio. 

 

Smart Investing
By Robin Bowerman
8 September 2006

Principal & Head of Retail, Vanguard Investments Australia
www.vanguard.com.au


30th-March-2007