What is a reasonable return?

A common New Years resolution is to get your finances in order and either start investing or sort out your portfolio. This resolution may be even more prevalent in 2021 after last year saw people’s finances upended unexpectedly.

As you set out to re-examine or start off with your investments, we offer a word of caution. Beware of chasing returns and if it looks too good to be true, it probably is.

Risk vs return

Investing 101 is about risk and reward. In Australia most of us consider the ten-year Commonwealth Bond Yields as a good proxy of the risk-free rate as it is a highly liquid security and backed by the government. The Australian 10-year bond rate has averaged around 0.9% over the past year.

Why is this rate important? Because if you are getting returns greater than the risk-free rate then you are being rewarded for taking on more risk and there is no exception to this simple rule.

When looking at investing also consider the long-term (20 year) annualised return of the ASX 200 Accumulation Index is 8.12%* and the current dividend yield of the market is 2.6%**.

Is it too good to be true?

So, when you look at investment opportunities quoting well above average figures or investments that use wording to suggest the investment is a cash product, like a term deposit, but the return is far higher than any term deposit you can find with a bank, ask yourself what additional risk is this investment taking to achieve that return.

In fact, ASIC are focusing on financial products and services that are using misleading or deceptive advertising. This also includes the mislabelling on term deposit “alternatives”.

It is especially important to understand realistic returns to help you avoid disappointment and worse, predatory practices taking advantage of people who have seen their finances upended and are looking for a quick win to get back to where they were. Basically, be sceptical. There is no such thing as a free lunch.

Focus on what you can control

Instead of looking to chase returns as quickly as possible we encourage you to focus on building good investment habits.

This starts with adequate diversification. Spreading your eggs over several asset class baskets such as Australian shares, international shares, bonds, property, infrastructure and cash. If the unexpected hits one asset class, you will have the others there to cushion the blow.

Secondly, consider your investment time horizon. This will help you decide on your risk profile. It is based on the theory if your investment was to decrease in value have you allowed enough time for it to recover. The longer the time frame, the more skewed you can afford to be towards growth assets such as Australian and international shares.

Thirdly, plan to continually add a sensible amount regularly if you are building your wealth. Put this on auto pilot and you will be surprised how quickly it builds up. It also takes away the question of “is now a good time”. Through buying more shares regularly you will use a strategy called dollar cost averaging.

Finally, make sure you keep a lid on your expenses. If you are using a managed investment product keep a close eye on management fees. Here at InvestSMART we have capped our management fees on all our diversified portfolios at $451pa. This is at the account level so you can have multiple InvestSMART portfolios in the one account and still only be charged a management fee of $451pa.

Below you will find a table of the returns from the InvestSMART Diversified Capped Fee Portfolios. They are portfolios designed to be true to label, blended with a mixture of asset classes in line with the suggested timeframe and risk profile.

If you were looking to make a change in the New Year or get started, please take a look. If you have any questions, we are here to chat via the online chat function in the bottom right corner of the page.

*Source: IRESS 31/12/2000 – 31/12/2020

**Source IRESS as at 31/12/2020