Thank you for downloading the Smart Investing podcast from index fund manager Vanguard Investments Australia, on the web at vanguard.com.au

This commentary is written by Vanguard Group CEO in the United States Bill McNabb. The title is Why take risks with your investments?

It was first published on Friday 18 May 2012

And is read by Michael Mullins

Please remember that advice in this podcast represents a general view. It is recommended that you seek specific financial advice, before making investment decisions. Figures and products quoted relate to US investor activity, but there’s some comparative Australian data at the end. 

We've been told by the financial community at large that it's a tough time to be an investor. 

The financial markets are extremely volatile. Bond yields are near historic lows. The outlook is uncertain.

So it's understandable that some investors are giving up on their basic portfolios of U.S. stocks. Vanguard calculations of Morningstar data show that investors have pulled $140 billion from U.S. stock funds over the past three years and are putting money into riskier sector funds ($83 billion in net inflow); emerging markets equity funds ($123 billion in net inflow); and alternatives such as commodities, currency and leveraged products ($136 billion in net inflow). On the bond side, investors appear to be reaching for higher yields in junk and foreign bond funds. And many more investors sit on the sidelines awaiting some sign that it is safe to go back into the stock market.

Meanwhile, some investment management companies are fanning the flames on risk. Preying on investors' hopes and fears, opportunistic firms have wasted little time creating new products and espousing new strategies, such as unconstrained, go-anywhere multi-asset funds and products based on increasingly narrow segments of the market. 

Brave new world? Not

After all, it's different this time.  A new normal.  A new world to brave.

Only it's not.

Markets have always been volatile and uncertain. Investment returns have always been unpredictable. And new and improved investment concoctions have always been marketed as the remedy. Think portfolio insurance, a strategy designed to reduce risk that ended up exacerbating the stock market crash of 1987.

To be sure, some new ideas might prove to have merit. But history and experience tell us that the way to financial security boils down to thinking simply and getting back to first principles, to paraphrase Frank Lloyd Wright.

Build stable foundation

The first principle — whether in architecture or investing — is to build a solid foundation. So it begins with constructing a balanced investment program with diversified exposure to the three primary asset classes: stocks, bonds and cash. If you do not have the time, inclination or confidence to assemble a prudent investment portfolio, buy a target date fund or enlist the help of a financial professional at, importantly, a reasonable cost.

Second, save aggressively. Between 12 per cent and 15 per cent of your take-home pay is a good guide. If you can't afford that level given your current financial circumstances, just save as much as you can.

Third, pay attention to investment costs. It's one factor you can control. You can increase your savings rate simply by paying less to your financial provider. The math is pretty simple: If you pay 0.20 per cent in expenses vs. 1.20 per cent, that equals a one percentage point boost in your savings. Use time to let that grow and compound on your behalf.

Finally, stick to your plan. It takes discipline to continue committing dollars in bad markets. It takes fortitude to remain invested during market swoons and to not alter your plan with dramatic shifts in your asset allocation. It takes restraint to resist chasing the hot sectors and hot hands.

There are no secrets here. No magic formulas. No complexity. How you invest. How much you invest. How much you pay to invest. How long you invest. These are the simple levers that can move you, if you will, to investment success.

Now a post script:

Are Australian investors showing similar patterns in their asset allocation?

Rainmaker data for 2011 shows a similar pattern of investment activity in Australia with a reduced investment in both Australian and International shares with the largest increases in investment activity into private equity, hedge funds and infrastructure. 

According to Rainmaker, in 2011, investments in listed property and Australian shares were down by 10 per cent and international shares down by 9 per cent, while hedge funds, private equity holdings and infrastructure holdings all experienced increased investments. Investments in cash including term deposits totalled $1.8 trillion, and Australian fixed interest up 12 per cent.

And that concludes the column

Why take risks with your investments?

from Robin Bowerman,  Principal, Corporate Affairs & Market Development at index fund manager Vanguard Investments Australia

To receive the column by email each week go to vanguard.com.au and register with Smart Investing. 

Please remember that advice in this podcast represents a general view. It is recommended that you seek specific financial advice, before making investment decisions. Figures and products quoted relate to US investor activity.