What impacts investment returns in the long term?

When it comes to investing, it goes without saying that the investment return is very important to the client.  It is imperative for a financial planner to manage a client’s expectations and ensure that they are happy with the risk and return they are likely to receive over the course of the investment.

Over the long-term, by far the biggest contributor to return is the asset allocation. The higher an investments exposure to growth assets such as shares and property, the higher the likely long-term return. Growth assets in the long-term have higher returns than cash and bonds; they also have much more volatility.

The reverse is also true; by adding cash and fixed interest to your investment portfolio, you add stability and reduce downside risk, but you sacrifice potential growth in the long-term for this added stability.

The length of investment and a client’s natural feelings towards investment risk will help us to identify the amount of volatility the client is prepared to accept.  This in turn determines the exposure to growth assets.

Short-term investments normally have a higher allocation to safer asset classes. The reason for this is that in the event of a bad year for growth assets, they won’t be invested long enough to recover with subsequent above average years. Long-term investments will have a range of both above and below average periods of performance, and over the length of the investment likely to end up with investment returns close to the expected average. Therefore, having a higher exposure to shares and property in order to increase the likely returns is a risk worth taking.

Financial planners try and limit the risk without negatively impacting the investment return. The main method is the use of diversification. The use of managed funds and index based investments is a method to spread your exposure.

Managed funds work by pooling the money of a number of clients and investing in a wide range of assets. Most superannuation funds are invested in this method or something similar. Different managed funds have different investment strategies and philosophies they use to choose their investment options. As financial planners, we try and select managed funds with different types of philosophies with the thinking that different approaches will lead to funds over and underperforming the average at different times, further reducing risk.