It's time to tighten your belt and pull up your braces.
The eagerly anticipated return of spring underlines that this exciting investment year is rapidly drawing to a close. The rejuvenation provides an ideal opportunity for us to review our investments and position ourselves for the year(s) ahead.
When constructing, or reviewing, an investment portfolio, you must to take into account various factors. The primary factors for consideration are your return objectives, risk profile, investment time horizon, ongoing and/or intermittent liquidity needs, and tax status.
You have all heard this a thousand times, but it can never be stressed enough: if you get it wrong at the start, the outcome is almost certain to disappoint and your objectives will not be met. The most difficult aspect of constructing a long-term investment port-folio is ensuring that your return expectations are realistic and can be met without you taking silly risks.
Having set objectives, it is useful to select a benchmark against which your asset growth and income requirements can be measured. The quality and appropriateness of your benchmark largely determine the investment universe in which you will operate. The benchmark should give you an indication of the expected risk attached to the portfolio and provides for a minimum return target.
Given the exceptional returns on domestic assets of the past three and five years ( see this table), investors' expectations of future returns have been positively skewed. I think we need to look at a slightly longer period for more helpful expectations.
It is evident from the table that if they invested in listed South African property and/or equity, investors have enjoyed annualised growth rates in excess of 40 percent over the past three years. Over the past five years, an annualised return of about 30 percent has been achieved. While extremely useful to an investor, especially those with a large asset base at the start of the period, the size of these returns bears very little resemblance to returns achieved over longer periods, which would include various economic, political and interest rate-sensitive periods.
Taking a 106-year view, the figures are different and should give some idea of very long-term trends and expectations. Over this period, nominal returns have been: equities, 12.6 percent; bonds, 6.7 percent; and cash, 5.9 percent. The real returns, taking inflation into account, have been: equities, 7.5 percent; bonds, 1.8 percent; and cash, one percent. This shows clearly that equities out-perform over the very long term, both in nominal and real terms and illustrates just how exceptional recent performance on "riskier" assets, such as shares, has been.
It could be argued that going back to the year 1900 is a little excessive, as our personal investment horizon is probably closer to 20 or 30 years. For cautious, long-term investors it seems realistic to look for returns in the 13- to 18-percent bracket to avoid disappointment. Remember that this is an average and there will be years with negative returns!
What should be immediately apparent is that if your investment objective is to out-perform a benchmark that is equity- and/or inflation-orientated (for example, CPIX plus four percent a year) and is to be measured over a reasonable time horizon, you require a large proportion of your assets to be exposed to the equity markets, with cash having no long-term strategic role to play in the asset mix and bonds having an intermittent, yet at times starring, role.
Investors typically shy away from equities if their investment time horizon is short (less than three years), and I agree entirely with this behaviour.
To arrive at a realistic expected return on equities you need to be aware that this is a function of known information, such as dividends, earnings and ratings, and of unknown or partly known issues of a socio-economic nature that impact on the global economy.
Given that the market is currently on a price:earnings ratio of about 15 allows investors to anticipate returns of about 15 percent a year on a rolling five-year basis from the broader market - if all things remain equal.
- David Sylvester is the chairman of the Shareholders' Association, telephone 021 686 7567.
This article was first published in Personal Finance magazine, 4th Quarter 2007. See what's in our latest issue