Remember the basic five when markets dive

By Matt Kerr - February 10, 2016

The markets might be in some rough waters, but there are some key points to follow for smoother sailing.

With 2016 off to a shaky start it is important to remember some basic principles to help settle any nerves you may be feeling.  Like anyone, we don’t like seeing the value of our investments decline but coming back to basics can help to keep things in perspective, so we will look at the 5 principles we come back to time and time again.

Turn down the “noise”

There is no coincidence that as the speed and amount of information increases the volatility in share markets increase – we have more information with which to make decisions and it is getting easier and cheaper to transact.  We need to be mindful about what information adds value and what information is just “noise”. 

Growth assets are for the long term

All of the information we have at our fingers is creating an environment that is focussing on the short term.  We need to remember if we are investing in growth assets this is for the longer term to help manage those longer term risks such as inflation and longevity.  Growth assets serve a purpose in your portfolio not for today, tomorrow or even next month, they are in your portfolio to help in 10, 20, 30 years time.

A loss is only a loss when it is realised

Although the value of your investments may go down from time to time, while you still own the asset you have a chance to reverse that reduction in value.  Once you sell the asset you have lost any opportunity to recover that reduction.  We still see many examples of this following the downturn in 2008 where people moved out of growth assets into cash.  In the years since, these people have averaged about 3.6% and still have not recovered the losses they realised by selling their growth assets.  On the other hand, assuming their investments were in Australian shares, if they held on to their assets they would have averaged a return of 10%per annum and would have recovered the reduction in value of their investments.

Asset Allocation is the key driver of returns

Studies on portfolio performance have concluded that asset allocation accounts for 94% of variation in returns of portfolios, leaving market timing and security selection to account for the remaining 6%.  What asset allocation is suited to you is driven primarily out of what you want to achieve and what resources you have, as well as how much risk you are prepared to accept with your assets.  Managing your portfolio in terms of your asset allocation can remove some of the emotion that may be present with investment decisions.  As the value of growth assets change, rebalancing your portfolio results in adding growth assets when they fall in value and reducing them when they have been performing well.

Yield is part of your total return

For people relying on their investments to meet living costs, yield is very important as this is the cash flow being generated from their investments.  However, yield is only part of the total return of an investment, with the other part being capital growth.  While the capital growth part of return may be negative, a strong sustainable yield is really what drives how much cash flow you have to spend.  

Whilst the total return of your portfolio may be negative, a look at what makes up this return is important to keep things in perspective. A well structured portfolio applies these basic principles so that in times of market downturns the cash flow from the portfolio can be maintained without having to the sell growth assets that have been acquired to provide longer term management of risks such as inflation and longevity. 

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