The most common question we get asked from existing or prospective clients is: “What investment returns can you get for me?”
This question creates a few problems. Firstly, it opens the door for unethical investment clowns, who often with the use of supporting colour charts about short-term historical performance, promise sky-high investment returns in order for them to get their hands on your money. The risks of investing based purely on recent historical investment returns are not mentioned to you at all.
We often ask ourselves: Is it not just people’s own greed that leads them into situations where they lose their money? Partly yes, but maybe it’s a cynical view in a lot of cases. Most people do not understand investments and can quite easily be swayed with proof of investment returns.
What investment returns can you get for me?
The fact that we get asked so many times about “what (or how much) returns”, shows that people do not understand the investment world. If you really want to be “safe” with your savings then a cash-type investment is probably the best bet. Current interest rates on a 12-month term deposit with the large trading banks range, on average, between 3.30% and 3.65% (before tax). Deduct 33% withholding tax from this and you end up with an after tax return of between 2.21% and 2.45%.You can also consider investing in government or corporate bonds, which may deliver a slightly higher interest rate (called a coupon), and are therefore also more risky.
There is much more involved in an investment than just interest. Interest alone offers the worst return over time and is fully taxable. Interest, excluding fixed –term interest, is generally not “safer” than an investment in a diversified fund, which invests your money in different baskets such as cash, bonds, shares and property. The potential to achieve higher returns over the long term (10 years +) by investing in a diversified fund increases, but this comes at a price and probably as no surprise, i.e. you need to take more risk with your investment funds to achieve a higher return.
Risk = uncertainty of returns
To determine the risk of an investment, and here we are not talking about investing in a dodgy finance company or Ponzi-scheme, we have to look at the uncertainty of returns (also known as the standard deviation).
We often wonder how many people, who are promised a 10% annual return on an investment, will in fact consider investing if they know that they can experience a15%-20% drop (or more) in the value of their investment in any given year?
Investments involve a lot more than return charts and the completion of forms. It involves more than “labelling” you a conservative, moderate, balanced or aggressive investor. Your so-called “label” means nothing to the market, and that’s where your money is invested.
If your financial adviser does not explain the risk of the product you are investing in – in writing, with their signature – ask yourself why. Do they not understand it themselves, or are they hiding something?
What is a good return?
So what is a good return? For some clients 5 to 6 percent real (after Inflation) per year is good. Using an average long-term inflation rate of 2%, it means their money is effectively growing by 3 to 4 percent and their money is “safe”. For others with a longer time horizon, 10 to 15 percent real per year or more is considered fair.
We believe a good return depends on your investment goals. It’s a balance between return and risk. We’ve had a decent bull (positive) market in local and international shares over the last couple of years. For example, the top 50 NZ-listed shares as measured by their market capitalisation (S&P/ NZX50 Index with imputation credits) delivered an annualised gross return of 14.8%, while the US S&P 500 Index delivered an annualised gross return of 13.5% in US dollar terms for the 5 year period ending 31 August 2015. Unfortunately this has created unrealistic investment return expectations.
The question is: what if the market falls? Will I be able to cope financially, or will I be able to safely “ride it out”? Our advice would be, particularly for older investors and those closer to, or in, retirement to start tempering their investment return expectations.