Episode Details

Episode 66 – The reality of negative returns - knowledge is power

Investment markets don't always go up.

In fact they go down on a pretty regular basis.

Is that a shock to you? I suspect not.

Yet virtually none of the commentary on investing talks about negative returns – markets going down.

But when I speak with clients, especially new clients, usually somewhere in their top 3 issues is not wanting to lose money – hardly surprising!

So in today's post, let's bust open this taboo subject and talk openly about the reality of negative returns.

So you're about to start investing. Your driver is the goal of growing your savings – building wealth, and with that comes the choices in life that is our central theme here at Financial Autonomy.

But you would be unusual if you didn't worry about losing your money. Mountains of behavioural finance research tells us that we humans fell loses much more powerfully than we enjoy equivalent gains.

So let's look at the realities. If you invest in a portfolio that is either 100% Australian shares, or 100% International shares, the data indicates you will experience a loss roughly 1 on every 4 years.

Now most people actually invest in a mix of assets – shares, both local and international, some property, and usually some conservative assets like cash and bonds.

For a typical Growth type investor, where the bulk of their assets are in shares and property, the likelihood of a negative return becomes around 1 in every 5 years.

A more conservative Balanced investor would be looking at closer to a negative return 1 in every 7 years.

Just a side note here – when I talk about a Balanced portfolio, I mean roughly 50% in growth assets like shares and property, and 50% in defensive assets like cash and bonds. You will find that some super funds offer a Balanced option, but when you look at the asset allocation it is far more heavily weighted to the growth assets – often it looks like a 70/30 split, which is more like a Growth allocation.

I just wanted to highlight that because it's a real problem in the investment industry – mislabelling of products. Don't assume that the Balanced option in your super fund has the 1 in 7 chance of a negative year. Take a look at how they invest your savings, and if it's weighted towards the growth assets, recognise that your chance of a negative year is likely to be closer to 1 in 5.

Now most in the Financial Autonomy community are in the building wealth phase and retirement is not imminent, so I'm going to work from here on the assumption you're going to invest in a Growth type mix of assets, and that means you should see a negative return about 1 in every 5 years.

Of course if you find that uncomfortable, you can invest more conservatively, and reduce that frequency. You might also want to take the risk level down a notch or two if your time frame is shorter – say 3 or 4 years.

But here's the key takeaway for you today – for Growth investors, 4 out of every 5 years, the value of their investments will go up. And that is a totally fine outcome.

What you want is a good outcome over the medium to long term. Short-term ups and downs don't matter, so long as you have structured things so you're not forced to sell at a bad time.

To illustrate this, consider two investors. One can't tolerate any years where there's a loss. So the solution for them is to invest in cash. Now they find an online savings account that pays pretty good interest, so let's say they earn 2%.

The other investor, whilst not a gambler, can tolerate a few ups and downs. So they invest in a typical Growth mix.

Now I've grabbed the data for the past 10 years – the year ending December 2008 to the year ending December 2017. Now the Growth mix sure enough had