Diversified Funds Are Practical For Many

Written By Russell Tym, Authorised Representative of MoneyLink Financial Planning, AFSL No 247360

Various investment ‘experts’ regularly predict higher returns from some sectors and lower returns from others, backed up by detailed economic analysis. They recommend placing more money in some areas and less in others.

The appeals of cash, fixed interest, shares, property and overseas investments fluctuate over time.

The forecasts are interesting to read and useful for people with new money to place, but those with existing investments find it impractical to make frequent changes from one area to another. Smart decisions require much study, and costs and capital gains tax must be considered.

Experienced investors usually find a diversified portfolio is the best option, some money in each area, with infrequent changes. They can choose a more conservative or growth oriented mix to suit their preference.

The simplest way to set up a diversified portfolio is to select one or more diversified funds. In these the manager monitors and varies the mix between the different investment classes as well as choosing specific investments in each class.

Diversified funds were only developed 25 years ago but fund manager AMP recently calculated the theoretical returns from such funds back to 1900.

AMP calculated the average compound returns from each sector, then used a mix of 40 per cent Australian shares, 30 per cent international shares, 25 per cent fixed interest and 5 per cent cash. Property was left out as no index measure since 1900 was available.

Typical management fees were deducted. The net result was an average compound return of 9.4 per cent per annum for 105 years. Inflation was 3.9 per cent per annum over the period. The return was much higher than money in the bank and makes balanced growth funds look appealing.

AMP also points out that the funds average annual return for the last three years has been 16.0 per cent, 14.0 per cent above inflation. Chief Economist Shane Oliver says returns are likely to decline to more normal levels, but not turn negative.

He says returns will fall for several reasons. Firstly the recent strong gains look like a typical rebound after a period of poor returns (2001-2003), and that rebound has now run its course. AMP’s figures show periods of flat or negative returns are usually followed by a strong rebound.

Secondly the low interest rates and easy money conditions of recent years are disappearing. Rates are rising in most countries, slowing share markets as less liquidity is flowing into them.

Thirdly company profit growth is slowing because of rising raw material costs and slower sales growth.

However Shane Oliver doesn’t think balanced or growth funds are likely to produce losses in the near future. He says past periods of negative returns have been preceded by overvalued share markets, high and sharply rising interest rates, or recession.

Currently share markets are not overpriced. They are trading at prices below their long term averages relative to profits. Inflation isn’t a problem and interest rates are low compared to the past. Growth is slowing but there is no sign of recession.

AMP also points out that in recent years diversified funds have been able to extend into new areas with more stability. Directly owned commercial property provides high returns with lower volatility.

Infrastructure investments like toll roads, airports and pipelines provide strong, consistent income streams. Shares in newly developing companies are another area of opportunity that behaves differently to traditional investment sectors.

Diversified funds enable small investors to seek higher returns without great risk. AMP expects these funds to earn around 9 per cent per annum over the medium term, and their returns have tax concessions. 

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