If you are investing for retirement income, Peter McGahan says diversify your investment strategy to ensure consistent returns.
A recent headline of ‘advisers should stop chasing unicorn consistent returns’ gave me indigestion.
As we have laid out here on numerous occasions in the past, simply leaving your money to the whims of a previous investment decision will cost you dearly.
Whether it’s your Personal Pension or your investments and ISAs, the gap between the worst and best is quite simply extraordinary.
So what did Morningstar mean when they made the statement of ‘chasing Unicorns’. Well, the truth is, if you ask the wrong or daft questions from the data you are looking at, the answer will inevitably be of the same quality.
Morningstar looked at how well a fund performed over a year, and whether or not it was in the top quarter of the funds they looked at. Stay with me on this, it will prove dividends.
In the last two months of the specific year they might have looked at, the fund could have gained by a random bet on anything that went well. It would now appear to be the best in that year, when it is just best over a two-month period, and you are now buying at a peak. Add to this, they are analysing top ‘quartile’. That’s like gluing jelly to a tree.
Futile: There are 260 funds to choose from in the UK all companies sector for example. ‘Top quartile’, therefore means ‘in the top 65’. Well done those guys. The top 65! Really?
65th place returned 2.0% last year. Last place (260th) returned – 27.5%, and the top fund returned 17.2%. Why would you measure across such vast numbers- i.e. a quartile? See note above re: jelly.
Nineteen years ago, we proved that analysis to be a guaranteed way to pick the wrong funds, yet it’s still used today.
It is perhaps the case, that true analysis is quite hard to explain in quick terms, and maintain the attention of the average consumer, or that those paying to be assessed don’t want to be assessed as deeply. Either way, the conclusion is incorrect.
Bo Derek did it with 10, or five stars does it with a hotel or fund, but in our hurry for an easily recognizable measure like this with investments, you will lose money.
Does consistency exist?
I took some funds you are likely to want to be invested into last year, and analysed how well they did over five years, broke it down into sixty discreet months and then put those into divisions of ten (not four – quartile – as is done above). Stay with me!
It shows some dramatic differences. Investors don’t want wild swings in portfolio returns. They want risk to be controlled and returns thought through. This way, you even out peaks and troughs. If I took the best fund versus the worst fund over each of the last four months in isolation, the inconsistency is highlighted dramatically.
The most inconsistent fund is the first number, the most consistent is the second: 0.008% versus 0.63%; 0.85% versus 0.88%; -0.16% versus 0.24%; -0.33% versus 1.71%. Over five, ten and twenty years, those differences will make a very big number indeed.
You may be surprised about the swings above in a low risk fund. Imagine, therefore, the difference in a medium or higher growth/risk fund!
FOLO driving poor decisions
The consistency is achieved by sticking to tried and tested methods of investing. Fear of losing Out (FOLO), greed, or ego can drive investors, and some notable recent high profile managers to be maverick and cool, when the answers easy. Returns are balanced out by spreading risk across excellent companies in a range of different markets and securities.
The excellent ice cream company, and the excellent welly boot company, mean that in normal conditions you will do well, but in extreme heat/rain, one balances out the other, and that’s what creates the smoothing.
That is also how opportunities are created to make money. A strong heat wave will push up the ice cream company shares, and push down the welly boot price. A redirection of the ice cream gains into the depressed welly boot is effectively the ultimate stabilizer. The key is to ensure your portfolio is realigned when necessary.
(Story source: 50 Connect)