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A good benchmark

21 May 2015  |  Investing

BenchmarkIn an era of low interest rates, investors have had to adjust their expectations across all asset classes. Over time, stock markets tend to return about 9% -- with the caveat that this only occurs if investors do not trade in and out of the market, but stay for the long haul (something that most small investors find very difficult to do).

So what should be regarded as a reasonable benchmark? Here is one perspective, whihc puts the level at about 7%:


"AMP Capital’s Shane Oliver sent a note to clients on Wednesday and made the point that in the early 1980s the RBA cash rate was about 14 per cent, the 10-year government bond rate was closer to 13.5 per cent and the three-year bank term deposit was 12 per cent. Inflation was running at about 9 per cent but the fear at the time was that it would head higher. In the end it didn’t, and when inflation started to fall and interest rates were cut it simply added to the returns that investors got.


Compare those numbers to the current cash rate that stands at a record low 2 per cent, the 10-year government yield at about 3 per cent and the inflation rate of close to 1.5 per cent.

According to AMP, after taxes and fees, superannuation returns averaged 14.1 per cent in nominal terms and 9.2 per cent after inflation between 1982 and 1999.

But now Oliver thinks that the sort of returns investors can expect to get is about 7.3 per cent. That compares with a 14 per cent return by the standard Australian balanced growth super fund during the period 1982 to 2007."


That kind of return requires skilfull diversification. Abd short term swings can muddy the waters:


"As Damien Wood from Spectrum Asset Management points out, if bond yields keep rising to anything like the levels they have been at in the past, then shares will suffer more sharp falls.

Indeed, on his numbers, if bond yields rise from 2 per cent to 4 per cent then shares could theoretically fall as much as 22 per cent.

The benchmark S&P/ASX 200 Index has fallen 6 per cent from its recent peak. Another 220 or so points and it will be in a technical correction.

So far in this sell-off, the yield on the 10-year government bond has risen from 2.28 per cent to just under 3 per cent.

The average yield on the 10-year bond over the past five years has been 3.97 per cent.

Go back a decade and the average yield is 4.71 per cent. So yields are still quite low when compared with the 1980s.

But if they do keep rising and the yield increases by 2 percentage points, then investors will probably suffer a 15 per cent fall in the 10-year government bond, and a 10 per cent fall if they are invested in the Bloomberg Australian Composite Bond Index."


This may turn out to be true, although it is just as likely to be incorrect. But if investors have diversified into bonds, however, then they should be able to deal with any volatility.




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