Today’s post is inspired by Marcus Padley’s recent article Priority No. 1: survival. Priority 100: sharemarket glory. Marcus is one of my favourite columnists. Even though he is a stock broker by trade, he does not always advise his readers to buy stocks. In this article, he gives his readers a pretty realistic view on what we can expect from the stock market in the coming years. For a 33 year period from 1974 to 2007, the All Ordinaries index delivered an average annual compound return of 11.7 per cent. However, for another 33 year period from 1941 to 1974, the average annual compound return on the All Ordinaries index was 2.9 per cent. I suspect that most of the people giving financial advice today are more familiar with the first 33 year period than the second one. Based on the returns of that period, it would be good advice to always maintain a high allocation to equities as the share market seems to always goes up over time. “Time in the market” was more important than “timing the market”.
Since 2008, the share market may have entered a period that is more similar to 1941 to 1974. The strategies that worked so well in the 33 years prior may not work anymore. According to Marcus, the risk-reward ratio of investing in equities has shifted and making money will take more effort. Making money when it’s more risky requires more discipline and skill so you need good trading skills; in particular risk management skills if you want to continue to be participate in this type of market. If doing this is too hard, then it is best to step out. Not losing money is good now and survival should be the No. 1 priority.
In our SMSF investment strategy, we specify a target annual return and ours is 5% above inflation. However, this does not mean that meeting that target return every year is my No. 1 priority. My top priority is Safety or Survival, just like Marcus. I recognise that investing is like fishing – I cannot predict how many fish I can catch in a year. I can only make sure I have good fishing equipment and skills but it also does not mean I should go out to fish everyday even when it looks like a big storm is brewing. It is better to miss out on catching a few extra fish rather than risk losing your fishing equipment. Seasoned investors like Alan Kohler who publishes the Eureka Report understand this. At the end of 2011, he announced that he was reducing his allocation to equities in his personal portfolio to 30% when he saw the risk of another major credit disaster in Europe. The disaster was averted by some last minute intervention by the Europe Central Bank and the markets rallied in December 2011. Some of his readers voiced their disappointment in missing the rally because followed him and stayed out of the market. I believe Alan did the right thing and he will have better results than most of his readers in the long run.
I hope all new SMSF trustees who plan to invest in the stock market will take a few moments to read Marcus’s excellent article and heed his simple advice – Make survival your No. 1 priority.