Grading your asset allocation efforts

This calendar year the ASX300 index started the year at 6653 points. In February, it got to a high of 7,115 points. It hit a low, in late March, of 4,500 points. As I write, the index sits at 6626 points. It was a year of remarkable volatility. 

To put these movements in percentage terms, it means that the index rose by 7 per cent (about the average annual growth we would expect from shares – the balance of returns would come from dividends) by February, fell from the top by about 37 per cent over the next month or so and then recovered by 47 per cent from the bottom over the remainder of the year.

This volatility makes for an interesting exercise looking back on the year to consider how well portfolios have managed to capture the benefit of this volatility – let’s face it, sell around the top, buy back around the bottom and receive some dividends along the way and it would be an extraordinary year for an investment portfolio.

Let’s assume, for the sake of this article, investors have a 70 per cent allocation to growth assets and 30 per cent to defensive (which would have provided fairly mediocre returns if invested in cash assets of less than 2 per cent per year). 

We will work out a possible return for every $100,000 of assets invested. As a high school teacher myself, I have pulled out the red pen and put together a scale of grades from an A down to an E.

Withdrawals or contributions have not been considered in these scenarios; you will have to make adjustments for these in your portfolios.

A : Great work – you are well and truly entitled to go to lunch early

To get an A , all you needed to do was to sell when markets were around their peak in February, and buy back in around the bottom in March – two trades in the year. The returns would have been impressive. 

For every $100,000 invested, your portfolio would have increased to $105,000 by the time of the February sale. Sell the portfolio at the top. Then, reinvest that $105,000 back into a 70 per cent growth/30 per cent defensive asset allocation in late March, the market low. 

Since that low, the $105,000 would have increased in value by about 33 per cent, turning the $105,000 into $140,000. Add some dividends and interest income, and the final portfolio balance would be around $143,000. 

In reality, this sort of market timing is basically impossible – however, two correct market timing decisions and the doom and gloom around 2020 would have seen it be a year of boom. Do that, and you will have deserved an A !

A: Nice work – shout yourself some extra seafood this Christmas season

I have set the standard for an A to be turning $100,000 invested at the start of the year into $125,000. To do this you are going to have to have made some strong market timing decisions, buying high and selling low. 

As a benchmark, if you sold around $45,000 of growth assets in the first six or seven weeks of the year (about ⅔ of your growth assets), and bought back in around the lows in March, this is the sort of return that you would have generated. 

Once again, these market timing decisions are notoriously difficult; indeed just think back to the ‘doom and gloom’ headlines of COVID in March this year – deciding to invest a large sum in shares at that point in the cycle was a tough decision to make. That said, if you had this degree of insight, you’re A is well deserved.

B: You stuck to a plan – heading in the right direction

I am going to award a B to anyone who stuck to the general plan of maintaining an asset allocation – using rebalancing to help ‘buy low and sell high’.

To get this mark the expectation is that around the bottom of the market, when growth assets had fallen in value by about 37 per cent, the decision was made to rebalance the portfolio by topping up the growth assets that had fallen in value, and therefore as a proportion of your portfolio. 

Timing this decision perfectly is unreasonable, so it is assumed the decision was made when markets were down 30 per cent, so you didn’t have to perfectly capture the 37 per cent downturn to be awarded a B. 

There is no heroic expectation that large parts of the portfolio were used to buy extra shares – just $5,500 taken from defensive assets to buy shares, which would return the portfolio to the 30 per cent defensive/70 per cent growth allocation. 

This $5,500, purchased when markets were down by 30 per cent, would have increased in value over the remainder of the year by $1815; adding to the $3,000 (approximately) of dividends and income interest received by the portfolio for a total return of just under $5,000 per $100,000 invested. 

Those shares held all year ended where they started in value. Overall, this is hardly a stellar investment return but keeps the portfolio well ahead of inflation in a challenging year by making just one automated investment decision.

I have not assumed any rebalancing of the portfolio at the market high, although in this article in January, I did discuss the fact that rebalancing after a good year of returns was an important strategy to consider and, if done, it would have increased returns a little bit further.

For the record, this is where my portfolio grading sits. I also have the relative advantage of making ongoing contributions to my investments (for example through employer superannuation contributions). I switched these to be predominantly growth asset investments during the downturn, which has also help support a reasonable return for the year. 

C: No damage done – things turned out OK in the long run

Give yourself a C if you did nothing and, over the year, interest and dividend income see you now sitting with a portfolio valuation a little above where you started. 

Your portfolio, excluding withdrawals or contributions, will have seen $100,000 turn into $103,000 – not a terrible place to be after a year where the portfolio value would have fallen to about $75,000 in March. 

Well done on holding your nerve – and you live to ‘fight another day’ while considering whether you want to make rebalancing part of your strategy. 

D or E – Things have not worked out well this year – stay behind after class and research the history of recoveries after falls in the Australian sharemarket

To get a D or E you have to have made some market timing decisions that have destroyed wealth – most likely you have made the decision to sell some shares at around the bottom of the market in March.

Indeed, let’s consider an investor who ‘gave up’ on shares around the bottom and, at that point, they sold their shares. They have recently bought back in on the back of the more positive commentary around COVID-19 vaccines. 

When they sold, their portfolio would have fallen from about $100,000 to $75,000, even assuming that they missed the absolute bottom of the market by about 500 points or so. 

Buying back in over the last couple of months would not have generated any capital growth, and they would have decreased their portfolio income returns by being exposed to cash and fixed interest investments. 

In the scenario of selling when the portfolio fell to $75,000 for every $100,000 invested, the best that could be expected would be a final portfolio value of around $77,000 to $78,000. 

Just as an aside to this – the average trading day in Australia sees somewhere around $1 billion of shares traded. During the month of March, when Australian shares were at the lowest, there were many days where more than $2 billion of shares traded hands – when markets were low, plenty of people were buying, and selling. And we now know exactly who got the best of those trades.

Let’s be clear about our grades. A ‘D’ result would be appropriate for an ending portfolio balance of $90,000 or better, and an ‘E’ for portfolios with a value less than this.

Conclusion

The rise and fall and rise in sharemarkets made for an interesting 2020, and an interesting wealth creation opportunity. 

Given that the overall price return from the market is basically zero per cent; all you had to do was get a couple of market timing decisions right and you could turn zero per cent into a remarkable 25 per cent (or better). Do nothing and you turned out a little bit ahead, on the back of dividends and interest. 

For those who use rebalancing as part of their strategy, a largely automated decision added an extra couple of per cent to what was an otherwise flat year. At the tougher end of returns, get a couple of market timing decisions incorrect, and the level of wealth destruction can be dramatic.