You may be the best person to manage your own money.
Psychologists call it ‘illusory superiority’. Most of us have it. Surveys in the US show that 88 per cent of people rate their driving skills as above average, while 90 per cent of college professors believe their teaching skills are above average, and only 1 per cent of high school students say their social skills are below average.
Of course, it’s impossible for everyone to be above average, even in Australia, but we see the same thing in investing. In my previous article in YourLifeChoices, I quoted research showing that the most experienced professional money managers struggle to deliver better returns (after fees) than a simple index that replicates the performance of all companies listed on an exchange. Professionals think they will outperform the market, but relatively few do.
In any case, selecting the right shares to buy or equity fund managers to invest with is not as important as most people think. A study by Vanguard (the second-largest fund manager in the world) of 580 balanced funds in Australia showed that 90 per cent of the return from a portfolio comes from asset allocation between sectors such as fixed interest, property and shares. That leaves only 10 per cent for everything else, including selection of particular shares. Yet most people spend more time worrying about their shares than their asset allocation.
If you are not an investment expert or do not have a lot of time to devote to investing and research, here are a few tips on how to select a diversified fund, with a focus on long-term saving and superannuation. Saving for short-term goals may be different.
Assess your appetite for investment risk
Investors who panic when the market falls, and buy when the market rises, achieve the worst outcomes. According to Dalbar, a research company that measures individual investor behaviour, the average investor in equity funds underperforms the index by at least 2 per cent. There is a natural behavioural tendency to buy high when the market is hot and sell low when the market is down.
A test of your risk appetite is how well you will sleep at night if your portfolio falls in value. The Australia stock market on average has a 10 per cent fall once every two years, and there have been three falls of over 50 per cent in the last 50 years. Your risk capacity may vary according to:
- Your investment horizon
- Your age and stage of life
- Your knowledge about investing.
Select a diversified fund that matches your risk appetite
The superannuation money of most Australians is managed by an institutional super fund (such as an industry or retail fund). Provided the fees are competitive, and none of the shenanigans revealed by the Financial Services Royal Commission affect your fund, it’s probably well-managed by market professionals using a wide variety of asset classes. It’s a good superannuation solution for the majority of people.
An asset allocation like the one in the table below has delivered returns of over 80 per cent over the last 10 years, even during the Global Financial Crisis of 2008. Choose a more conservative mix if you are risk averse or older, and if you worry about the value of your investments falling. If you’re under 50, a more aggressive portfolio is suitable since you have time to invest more and better capacity to ride out the inevitable share market volatility.
Choose a suitable fund, perhaps with financial advice, and then leave your money there and don’t be tempted to swap styles unless your risk appetite changes.
Asset allocation of superannuation funds excluding SMSFs
Source: Association of Superannuation Funds of Australia (ASFA)
Manage your costs
While you cannot control the market, you have more influence over what costs you pay. The three major costs to watch are:
- Investment management fees
- Administration fees, such as the cost of an investment ‘platform’
- Financial advice fees.
Anyone who has followed the Financial Services Royal Commission will know there is a wide range of potential fees. Learn what you are paying. There are plenty of quality diversified funds that cover investing, full-service administration and call centre support for around 0.75 per cent of the fund balance a year. Personal financial advice might cost an additional 0.75–1 per cent. Anyone paying more than about 1.5 per cent all-in should ask for a better deal or move.
Turn down the noise
Try not to jump in and out of investments simply because a fund manager is not ‘top of the market’, or a strategy has not worked initially. Investing should be part of a multi-decade plan. Turn down the volume on the daily market noise and unless you enjoy it or have special skills, don’t waste too much time on individual shares or funds. It’s the high-level asset allocation that will mainly drive your return and volatility.
Educate yourself about your choices
As you become more familiar with investing, or perhaps when you have more time and money, your range of investing options will widen. For example, there may be benefits in establishing your own self-managed super fund (SMSF), as it can invest in a wider range of assets than a public offer fund. There are now more types of securities available on the Australian Securities Exchange (ASX) than ever before. By opening an account with a broker, you can buy Exchange Traded Funds and Listed Investment Companies which include inexpensive index funds or exposures to specific market segments. Start with small amounts of money and learn as you go. We will explain these choices in future articles.
Don’t kid yourself about your investing superiority as the vast majority of investors will not outperform the market. Just as you’re not the next David Beckham, so you’re not the next Warren Buffett. An investment plan that suits your personal circumstances, in a managed fund that matches your risk tolerance, is a good solution. Most people with either a large amount of money to invest, or facing a lifestyle event such as retirement, will benefit from seeing a financial adviser.
Graham Hand is Managing Editor of the leading financial newsletter, Cuffelinks. Graham writes regularly on investing for YourLifeChoices. Cuffelinks will always be free for YourLifeChoices subscribers and includes the insights from hundreds of market experts. You can register to receive the newsletter here. This article is general information not personal financial advice.
Disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.