by Kathy Cave, Portfolio Manager, Russell Investment Group
When things are going well, we relax and let down our guard. Perhaps become over-confident. Homer’s epic The Odyssey provides a cautionary metaphor for those navigating the world’s investment markets…
The Australian sharemarket rose 30.22% in the year to 31 March 2006. Over the last three years it has returned an annual average of 26.45%. In a strong market like this it’s easy to lose sight of your core objectives, become less concerned about risk, and end up with more money in the market than you otherwise might.
After several years invested in a strong market, unless you’ve rebalanced your portfolio to its original mix (or invested in a diversified fund that does it for you), you’ll find the percentage of funds you have in that market has risen significantly. Consequently, your exposure to its risks is greater.
Say you invested $10,000 three years ago by putting $7,000 (70%) into Australian shares and $3,000 (30%) into bonds. You haven’t touched it since. At the end of March this year, your investment would’ve been worth $17,650 of which $14,154 (80.19%) would’ve been in shares and $3,496 (19.81%) in bonds. A fabulous return, but your level of risk has increased too, because shares now represent a larger percentage of your investment. You’re more vulnerable to a market fall than you would be if you rebalanced to your 70–30 split.
What’s Homer got to do with it?
Around 800BC Homer composed the epic poem The Odyssey, which follows Odysseus, king of Ithaca, on his voyage home after the Trojan War. Like all great art, the poem can be interpreted on many levels. By reading Homer’s tale as a metaphor for our journey through the investment markets we find some useful guidance for modern investors.
Setting your asset allocation (the proportion invested in each investment type–local and international shares, property, bonds) is the most important investment decision you make. Using our metaphor, it’s the course you steer. It is therefore the most important factor in determining whether you reach your destination of financial freedom in retirement. Two pieces of advice in The Odyssey are beneficial.
1. Avoid the temptation of the sweet singing Sirens
Circe, a goddess, tells Odysseus which course to take and explains the dangers. “First you’ll encounter the Sirens,” she said. The Sirens are sea nymphs who lure passing sailors to certain shipwreck with the beauty of their song. “Pass these Sirens by,” said Circe. “Plug the ears of your crew with beeswax, that none of them may hear.” Odysseus wanted to experience the seductive singing, so Circe advised him to have his crew lash him to the mast so he could listen without being able to act on the Sirens’ words. The more you plead with your crew to untie you, she said, the tighter they should bind you. It worked. Odysseus and his crew safely passed by the Sirens.
Modern Sirens include those during the technology stock boom who crooned intoxicating tales of a world where ‘dotcoms’ dominated, profits were ‘passé’ and growth was everything. Promises of easy wealth saw investors shift large sums into technology stocks during 1999 and early 2000. The NASDAQ technology index rocketed to an all-time high of 5048 in March 2000, almost double its level of a year earlier. If only investors had ‘lashed themselves to the mast’, they might have avoided shipwreck. From its high in March 2000, the NASDAQ fell to 1114 by October 2002, a loss of 78%.
The Sirens still sing just as sweetly: Continued double digit returns from Australian shares, the booming energy and resources sector, opportunities in fast-growing China.
This is not to say avoid these areas completely – most well diversified portfolios do contain them – but don’t be lured into investing beyond a prudent asset allocation. If your desire to make an investment is based on its recent performance, you’re better off ‘lashing yourself to the mast’.
2. Sacrifices are necessary when navigating treacherous waters
Next, Odysseus faced a more daunting challenge. To sail through a narrow strait between the whirlpool of Charybdis, which would completely destroy his ship and crew if they were caught in it, and the six-headed sea monster Scylla, who would use those heads to devour six of his men as he went past. The two sides of the strait were within an arrow’s range of each other. The key, Circe said, was to avoid Charybdis’s whirlpool, which would lead to certain destruction. Sail closer to Scylla and pass as quickly as possible.
“Isn’t there some way I can pass Charybdis while also protecting my crew from Scylla?” asked Odysseus.
Today’s investors will recognise the dilemma as they guide their investments through the narrow channels of volatile markets. In the tech stock boom, not to invest meant missing huge returns, while investing risked financial ruin.
Each of Scylla’s six slavering maws did indeed grab one of Odysseus’s men. This was the sacrifice he made to save his ship and the rest of his crew from certain death. There was no way for Odysseus to avoid both dangers.
Sometimes, on your investment journey, such sacrifices will be necessary. By adhering to your asset allocation you’ll lose money by remaining invested in shares in a falling market and you’ll miss out on maximum profits by not increasing your share allocation in a booming market. But over the long journey to retirement, staying your course and making these sacrifices means you’ll arrive safely in the end.
Better to sacrifice a few dollars to Scylla, than sail too close to Charybdis and lose the lot.
What should investors do?
1. Review and rebalance
Now is a good time to review your investments and, if necessary, rebalance to your chosen asset allocation. If you’ve never set an asset allocation, see the next section below.
2. Diversify internationally, not just locally
It’s tempting to invest predominantly in Australian funds, especially as our sharemarket has done so well. Yet the Australian market represents less than 3% of world markets; 97% of the world’s investment opportunities lie beyond our borders. Widening your asset allocation to include international funds broadens the channel you’re sailing in, which significantly reduces investment risk because you’re no longer dependent on the Australian market performing well.
Focus on your destination
Today it’s our booming resources sector and growth in China making the news. Next year–who knows? There will always be tempting opportunities to divert you from your course. Successful long term investors, those who arrive safely at their destination, are the ones who set a clear course and stick with it.
Setting your asset allocation
The most appropriate asset allocation depends on your age, how long until you retire and how much risk you can bear.
View your current asset allocation on our Web site. Log in and select ‘Investment Choice’ then ‘Your asset allocation’. A pie chart shows what proportion of your super is invested where. Is that asset allocation the right one for you?
If you’re invested in a Russell LifePoints Target Date Portfolio we determine an appropriate asset allocation given your retirement date and regularly review it for you. All you need to do is choose the fund that matches your target retirement year.
If you’re invested in Russell LifePoints Diversified Portfolios we professionally manage the asset allocation to suit the fund objective. You need to choose the right fund for you. See point 3.
If you’re invested in our Build-Your-Own Portfolios, or you want to know which diversified portfolio might be right for you, do the quick Investor Style Quiz on our Web site. An appropriate asset allocation is suggested based on your answers.
Achieve is issued by Russell Investment Management Limited (RIM), ABN 53 068 338 974, AFSL 247185. In preparing this information we haven’t taken into account your own personal circumstances, including what you want and need for your financial future. It is important for you to consider these matters and also to obtain and read the relevant PDS before you decide whether to acquire or to continue to hold a product. Go to www.yoursupersolution.com.au to download a PDS. Interests in Russell SuperSolution are issued by Total Risk Management Pty Ltd.
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When things are going well, we relax and let down our guard. Perhaps become over-confident. Homer’s epic The Odyssey provides a cautionary metaphor for those navigating the world’s investment markets…