What's the best asset of the decade?

The 2016 ASX/Russell Long-term Investing Report was released last month and it contains valuable data about what has happened in various asset classes available to Australian investors over the past 10 and 20 years. The report is particularly interesting because it calculates after-tax returns – something that is too often forgotten by investment managers, who only provide before tax returns.

There are a number of important observations here, including the challenge of finding investment returns over the past 10 years (a time period dominated by the GFC), evidence for the “myth of the 10 year holding period”, wealth destruction from gearing strategies for Australian shares and the strength of residential property over the past 10 and 20 years.

The past 10 years

It's close to ten years since the Australian share market hit its 2007 high – it is still some 30 per cent below its peak nine years later. It goes without saying that the Global Financial Crisis has created a challenging environment for investors, with both drops in the value of growth assets and historically low cash rates.

In Australia, the average annual return from investing in Australian shares for the 10 year period to the end of December 2015 was 5.5 per cent per annum. With inflation being 2.6 per cent per annum, Australian shares provided a “real” return of just 2.9 per cent per annum – a pretty lousy return for the extraordinary amount of volatility over this time period. That said, a buy and hold investment in the average portfolio of Australian shares turned $100,000 into $170,800 – a result that at least helped create wealth over that time period.

The return from investing in cash over this period was even less exciting, 3.1 per cent per annum, beating inflation by 0.5 per cent per annum. $100,000 invested in cash over this period was worth $135,700 at the end.

The following table sets out the 10 year returns from key asset classes – including after tax in a superannuation accumulation fund and the highest marginal tax rate.

Table 1 - 10 year returns to end December 2015

Returns (per cent p.a.)

Table 2 - 20 year returns to end December 2015

Returns (per cent p.a.)

It's interesting that, when looking at the 20 year returns, Australian shares start to look far more attractive. A buy and hold investor who captured the average return across this period would have seen a $100,000 portfolio turn into $530,000. Of course, if you achieved a higher return the result would have been even more attractive.

The myth of five, seven and 10 year holding periods

I have seen many investment providers suggesting that a holding period for growth-style assets should be five, seven or ten years – the implication being that investors will have a successful investment experience if they have the discipline to hold for that long.

Ten years of holding a well-diversified portfolio of Australian shares, cash, listed property and global shares (unhedged) would have provided an investor with a return of 3.7 per cent per annum, effectively a return of 1.1 per cent better than inflation. For an investor on the highest tax rate? This would be 2.3 per cent per annum. This is below the 2.6 per cent inflation rate, and shows that there have been poor periods of investment returns longer than 10 years that have provided unsatisfactory returns.

Investors should be aware that there is no guarantee of a positive real (after inflation) return for investing over five, seven or 10 years.

An insight into gearing

Another innovative calculation provided in the report is on the role of gearing in a portfolio. The reporting finds that over the past 10 years, a gearing (borrowing to invest) strategy with Australian shares actually reduced your average annual return.

For an investor on the top marginal tax rate, the return from shares was 4.0 per cent per annum over the 10 years to the end of December 2015. If they geared (using a 50 per cent gearing ratio), that return was reduced to 3.2 per cent per annum. To put numbers on it, a $100,000 investment for a person on the highest tax bracket in Australian shares increased in value to $148,000. If they borrowed to invest, it only increased to $138,000. For all the extra volatility that the gearing strategy would have caused, it also destroyed $10,000 of wealth. This might be why the value of margin loans has fallen so sharply over the past 10 years, with investors deciding they have had enough of gearing as a strategy.

For an investor on the lowest marginal tax rate, their return was 5.8 per cent per annum from investing in Australian shares over the 10 years to the end of December, and fell to 4.6 per cent per annum with a gearing strategy.

The strength of residential property

Over the past 10 and 20 years residential property has been the strongest performing asset class. The calculations in the report have taken into account "vacancy rates, maintenance expenses, management fees, government charges, land tax and insurance", with buying and selling costs including "conveyancing, stamp duty and agent fees". Even with these fees and taxes considered, residential property has been the strong performer. Of course, that is no guarantee of a future returns and, for those who make the argument that falling interest rates have supported property price rises, a period of rising interest rates would provide a different investment environment.

Conclusion

While historical data is interesting to reflect on, it has limited value in predicting the future. This latest Long Term Investment report challenges 10 years as being a “safe” investment holding period, highlights the risks with even a long term gearing strategy and shows how strong the returns from residential property have been over the past 10 and 20 years. For share market investors, the returns from the last 20 years have certainly been adequate, and from the past 10 have at least stayed ahead of inflation, even over the period of the Global Financial Crisis.