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The best of times, the worst of times

SMSF investors face a challenging outlook in 2019 of lower return expectations coupled with the promise of more volatility. Their advisers may expect that one of the big questions for the year ahead is how best to tailor an SMSF portfolio to tackle this investing environment.

This is where your guidance can be invaluable given the consequence for investors altering course in reaction to a volatile market has been the undoing of many a sound investment strategy.

Without sound advice reacting to the bad days often results in investors crystalising losses and missing out on the recovery because the best and worst days tend to cluster tightly together during bouts of volatility. So if you sell at the wrong time, you are selling at a low in addition to running the risk that you will miss a rapid recovery.

Vanguard’s investment strategists have tracked back over the past 30 years in the Australian share market (using S&P/ASX 200 Index data) to map the highs and lows of the most volatile periods.

In aggregate, what this analysis shows is a median return for the worst 100 days of -2.3 per cent compared to 2.1 per cent for the best 100 days.

Looking at the detail, it highlights how quickly the market can recover or bounce back following a sharp dip, presenting a compelling reason for taking an ‘informed but not alarmed’ approach to volatile markets.

Take the election of United States President Donald Trump in November 2016 as an example. That day the Australian share market dipped nearly 2 per cent before a sharp rebound the following day of 3.3 per cent. If investors panicked and sold their shares on 9 November, not only did they lock in the 2 per cent losses, they also missed a rebound and gain the following day.

The Brexit referendum results produced a pattern of events in markets a few days apart where we had a 3.2 per cent decline on 24 June 2016, followed by an uptick just six days later of 1.8 per cent, and the market surpassing the prior peak just two weeks after the Brexit vote.

More recently in November 2018 the market dipped 1.5 per cent followed by a 1.8 per cent recovery just three days later, reflecting the fluid nature and uncertain landing point arising from US/China trade policy.

Sadly, no one rings that bell and tells you which day these rebounds will happen, which is why, as the late Vanguard founder Jack Bogle said: “The stock market can be a distraction to the business of investing.”

But an adviser’s role as a behavioural coach can serve as the circuit breaker for knee-jerk reactions to volatile times.

That said, investors should adjust expectations for lower returns and a return to more normal levels of volatility going forward.

The “Vanguard Economic and Market Outlook for 2019” report projects a balanced portfolio containing a 50:50 split between equities and bonds will deliver around 4 per cent to 6 per cent a year before tax over the next 10 years, well below the level of the past five years, with most balanced funds having delivered around 7 per cent to 9 per cent a year.

There are several options available to improve outcomes in this climate, but there are also some common pitfalls that, more often than not, lead to future disappointment.

In the latter category is the desire to increase risk to seek higher returns. This can come in many forms, whether it is the chase for yield, which has led to investors accepting greater levels of stock concentration in high-yielding shares often with a strong bias to home-country equities, or outright speculation, such as the attention cryptocurrencies have attracted despite limited understanding of the risk and return drivers.

Substituting traditional defensive assets, such as fixed income securities, for higher-yielding credit or high-yielding shares can also dramatically change the risks within a portfolio. All of these actions have the potential to deliver results that are dramatically wider than an investor can tolerate and compromise their long-term investment goals.

To achieve investment goals in a low-return environment, investors who save more, adjust their spending, rebalance their portfolios and reduce costs can materially benefit their SMSF without taking on excessive risk.

Investors nearing retirement should ensure the risk profile of their portfolio matches their goals and stage of life.

Measuring the impact of these adjustments against strategies such as asset class tilts has shown they can materially improve investment outcomes.

Aidan Geysen is head of investment strategy at Vanguard Australia.

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