Key points
- While growth assets like shares go through bouts of short-term
underperformance versus bonds and cash, they provide superior longterm
returns. So, it makes sense that superannuation has a high exposure
to them.
- The best approach is to simply recognise that occasional sharp falls in
share markets and hence super funds are normal and that investing in
both is a long-term investment.
Introduction
“Aussie share market loses $100bn in bloodbath”
Two weeks ago, there were lots of headlines like that after share markets fell sharply
in response to US recession fears. But such headlines are nothing new. After such
falls, the usual questions are: What caused the fall? What’s the outlook? And what
does it mean for superannuation? The correct answer to the latter should be
something like: “Nothing really, as super is a long-term investment and share market
volatility is normal”. But that can seem like marketing spin. However, the reality is that
– except for those who are into trading – shares and superannuation really are longterm
investments. Here’s why.
Super funds, shares & the power of compound interest
Superannuation seeks to provide maximum risk-adjusted funds, within reason, for use
in retirement. So typical super funds have a bias towards shares and other growth
assets, and some exposure to defensive assets like bonds and cash in order to avoid
excessive short-term volatility. This approach seeks to take advantage of the power of
compound interest. The next chart shows the value of a $100 investment in Australian
cash, bonds, shares and residential property from 1926 assuming any interest,
dividends and rents are reinvested on the way, and their annual returns. As return
series for commercial property and infrastructure only go back a few decades I have
used residential property as a proxy.
Long term asset class returns
Source: ASX, Bloomberg, RBA, REIA, AMP
Because shares and property provide higher returns over long periods the value of an
investment in them compounds to a much higher amount over time. So, it makes
sense to have a decent exposure to them. The higher return from shares and other
growth assets reflects compensation for their greater risk (seen in volatility &
illiquidity) versus cash & bonds.
But investors don’t have 100 years?
Of course, we don’t have one hundred years to save for retirement. In fact, our natural
tendency is to think very short term. And this is where the problem starts. On a dayto-
day basis shares are down almost as much as they are up. See the next chart. So,
day-to-day, it’s pretty much a coin toss as to whether you will get good news or bad
when you tune in for the nightly finance update. But if you just look monthly and allow
for dividends, the historical experience tells us you will only get bad news around a
third of the time. And if you only look each year, you will only get negative news 20%
of the time for Australian shares and 27% of the time for US shares. And if you look
just once a decade, positive returns have been seen 100% of the time for Australian
shares and 82% for US shares. So, while it’s hard given the bombardment of financial
news these days it makes sense to look at your returns less because then are you
more likely to get positive news and less likely to make rash decisions or end up
adopting an investment strategy that it too cautious.
Percentage of positive share market returns
Daily & mthly data from 1995,yrs & decades from 1900. ASX, Bloomberg, AMP
This can also be demonstrated in the following charts. On a rolling 12 month ended
basis the returns from shares bounce around all over the place versus cash & bonds.
Investment returns over rolling 12 month periods - Australia
Source: ASX, Bloomberg, RBA, AMP
However, over rolling ten-year periods, shares have invariably done better, although
there have been some periods where returns from bonds and cash have done better,
albeit briefly.
Investment returns over rolling 10 yr periods - Australia
Source: ASX, Bloomberg, RBA, AMP
Pushing the horizon out to rolling 20-year periods, returns from shares have almost
always done even better, although a surge in cash and bond returns after the very
high interest rates of the late 1970s/1980s saw the gap narrow for a while. Over rolling
40-year periods – the working years of a typical person – shares have always done
better.
Investment returns over rolling 40 year periods - Australia
Source: ASX, Bloomberg, RBA, AMP
This is consistent with the basic proposition that higher short-term volatility from
shares (often around periods of falling profits & a risk that companies go bust) is
rewarded over the long term with higher returns.
But why not try and time short-term market moves?
The temptation to do this is immense. With the benefit of hindsight many swings in
markets like the tech boom and bust, the GFC and the plunge and rebound in shares
around the COVID pandemic look inevitable and hence forecastable and so it’s natural
to think “why not give it a go?” by switching between cash and shares within your
super to anticipate market moves. Fair enough. But without a tried and tested market
timing process, trying to time the market is difficult. A good way to demonstrate this
is with a comparison of returns if an investor is fully invested in shares versus missing
out on the best (or worst) days. The next chart shows that if you were fully invested in
Australian shares from January 1995, you would have returned 9.5% pa (with
dividends but not allowing for franking credits, tax and fees). If by trying to time the
market you avoided the 10 worst days (yellow bars), you would have boosted your
return to 12.2% pa. And if you avoided the 40 worst days, it would have been boosted
to 17% pa! But this is really hard, and many investors only get out after the bad
returns have occurred, just in time to miss some of the best days. For example, if by
trying to time the market you miss the 10 best days (blue bars), the return falls to
7.5% pa. If you miss the 40 best days, it drops to just 3.5% pa.
Missing the best days and the worst days
Source: Bloomberg, AMP
The following chart shows the difficulties of short-term timing in another way. It
shows the cumulative return of two portfolios.
A fixed balanced mix of 70 per cent Australian equities, 25 per cent bonds and
five per cent cash;
A “switching portfolio” which starts off with the above but moves 100 per cent
into cash after any negative calendar year in the balanced portfolio & doesn't
move back until after the balanced portfolio has a calendar year of positive
returns. We have assumed a two-month lag.
Comparison of constant strategy versus switching to cash after bad times
Source: ASX, Bloomberg, RBA, AMP
Over the long run the switching portfolio produces an average return of 8.6% pa
versus 10% pa for the balanced mix. From a $100 investment in 1928 the switching
portfolio would have grown to $279,236, but the constant mix would have ended more
than 3 times bigger at $931,940.
Key messages
First, while shares and growth assets have periods of short-term underperformance
versus cash & bonds they provide superior long-term returns. So, it makes sense for
super to have a high exposure to them.
Second, switching to cash after a bad patch is not the best strategy for maximising
wealth over time. In fact, it can just lock in losses.
Third, the less you look at your investments the less you will be disappointed. This
reduces the chance of selling at the wrong time.
The best approach is to recognise that super and shares are long-term investments
and adopt a long-term strategy to suit your circumstances – in terms of your age,
income, wealth and risk tolerance.
Finally, anything that cuts your super balance early on can cut your super at
retirement a lot. Eg, a $20,000 withdrawal from super at age 30 – say for a dental
expense - can cut your super at age 67 by around $74,000 (in today’s dollars) due to
the loss of compounding returns on that amount (using the assumptions in the ASIC
MoneySmart Super calculator).
Dr Shane Oliver - Head of Investment Strategy and Chief Economist, AMP
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Thisdocument has been prepared for the purpose of providing general information, without takingaccount of any particular investor’s objectives, financial situation or needs. An investor should,before making any investment decisions, consider the appropriateness of the information in thisdocument, and seek professional advice, having regard to the investor’s objectives, financialsituation and needs. This document is solely for the use of the party to whom it is provided.
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