Probably the most important theory in financial planning is Asset Allocation.  Essentially the assumption that the returns you can expect over the medium to long term can be determined by what you buy.  Bonds get lower returns, while equities get higher returns.   For a long time the all academic research pointed in that direction, supported by industry research suggesting equity returns in 7-8% range.  These numbers are quoted so often it isn’t considered cliché so much as a truism by the industry.

Recent, broader and deeper research however has thrown doubt on this suggesting a much lower rate of 3%.   This is some well conducted research, so it bears some examination.

It also has profound implications for investors and financial planners.  These are…

Asset Allocation IS the mainstream

It helps to understand why it matters so much. The key piece of research on returns is asset allocation indicating that selecting equities as an asset class represents 90% of performance is in a study by Brinson, Hood and Beebower.  It isn’t just accepted; far more than that.   This study and the others that followed are THE mainstream cornerstone of investment strategy.  It is used by pension funds, taught by all major investment courses and is the foundation strategy of financial planners globally as taught by both CFP and CFA institutes.   Everyone assumes that equities will return 7-8% and the equities are the highest performing asset class.  The major choice is how much equities to buy to get you close to 7-8% long term.

America in the 60-70s isn’t a population survey.

The one problem was that research has been US focused since most researchers are themselves American.  Don’t blame them, most researchers (and investors for that matter) have a home bias.  As this Economist article mentions, America didn’t have a bad 20^th century.   When you go wider, much wider, to include all stock market history including all markets including Russia, China, and Austria and include their failures; things don’t look so pretty.  In fact the research suggests that equities return 4% in the long term, not the 7-8% that is commonly accepted and expected.   That’s not a small difference.

Small differences in cost matter.

If there is a chance that your stock market investment will only do 2-4%, then small changes in cost matter greatly.  If your investment product has fees in the 4% range, then there is a good chance you will make nothing at all.  Reducing it to 1% or less should be a high priority goal for any investor.  We have spoken on this before (discount brokers, discount brokers), and will again soon.  Funds that are exchange traded have recently becomemainstream and are the best approach.

The past is no guide to the future

It may appear that we are doomed to low returns.  We are not.  It is worth pointing out that there is an awful lot of variance in the results.  Some decades and long periods can be both wonderful and awful.  The 1970s was dreadful with a 40% decline for the US market.  The Japanese market is still around two-thirds below its 1990 peak more than two decades later.  America had a great 1990’s as well as 1920’s, 1950’s and Australia had one of the best total returns out of any market (mostly due to dividends in the 3-6% range) during the 20^th century.  The record is mixed and points directly to two major learning points.

Exceptional results can happen, based on underlying economics

Argentina and Russia were, at one point, competitors to the US and failed in varying degrees.  America succeeded and dragged its market with it.  Where is the next America of the 21^st century?  China?  Indonesia?  Brazil? India?  All could be mentioned as likely candidates.   The record suggests that those investors who keep these markets as a small percentage of the “emerging market” bucket are potentially doing themselves a grave disservice.  It also suggests that ignoring economic macro mismanagement is not a wise strategy.   Russia in particular springs to mind here.

But what about the US going forward?

Another piece of research, again on the Economist website (have you got a subscription yet!) has looked at what might be expected over the next ten years.  The methodology based on Shiller PE and market wide dividend yield.   The results for the United States stock market are similarly sober, the one for government bonds horrific, but the outlook for property is considerably brighter.   There are ways, besides buying a house yourself, and the associated management headache, to invest directly in property.  To learn more email us on admin@caterergoodman.com.

So what do I take from this?

A few things:

• Look widely for opportunities since the past doesn’t guide the future.
• Economic growth matters in the medium to long term.
• Valuation and dividend yield always matter.
• Emerging markets may well represent the future, and we have discussed China recently.
• Property in developed economies could be interesting.
• Bonds have been great recently, but are due to underperform sometime soon.

Don’t go it alone

The final thing to remember is that investing shouldn’t be a solitary pursuit.  There is so much to learn. We run open self-invest workshops regularly.  The next event is March so join us.

We have also trained clients in managing their own money so email us here admin@caterergoodman.com or call (021) 3366 1337.   We believe in clients and expatriates in general understanding investment options better.  We run training programs, and lend investment books too.  Does your financial adviser do that?

Something Different: Transparent Professional Advice.

About Caterer Goodman Partners

Caterer Goodman Partners is a Shanghai based wealth management firm established with a clear vision to provide a new level of personalized financial planning services for expatriates in Asia. Our financial advisors provide guidance for our clients in all areas of investment, specialising in managed accounts, money-market funds, retirement planning and alternative investments. At Caterer Goodman Partners, we offer our advice and experience to provide low cost, tax-effective and simple solutions to match our clients’ interests.

About Owen Caterer

Since graduation Mr Owen Caterer has worked with the Queensland Premier's Department in Trade Facilitation and then as a financial adviser in Shanghai from 2005 until 2010.  He then rose to Senior Adviser, then Business Development manager and then to Chief Investment Officer responsible for portfolios to a value of US$280 million across Asia. Following that Mr Caterer left to found his own firm with a partner in the financial advisory and wealth management area.   This focused on developing China and Asia's first fee-based financial advisory (rather than commission-based). This has grown to now have 8 staff and and managing almost US$35 million for clients throughout Asia. This business success was recognized as a finalist in the 2013 ACBA in the Start Up Enterprises category and are one of a small number of foreign managed firms to have a full asset management license in China.  Owen has also been active in the community volunteering for the Australian Chamber of Commerce in Shanghai and acting as the Vice-Chair of the Small Business Working Group (2012-2014) and as the Co-Deputy Chair of the Financial Services since 2013 until the present. They have continued to grow their business and have now been selected as a small group of companies who are platinum members of the Australian chamber of commerce. The achievement they are most proud of is their efforts to reform the financial planning industry in China and push it away from a hard-sales commission driven model to a more ethical management fee and long term customer service model.   Owen has a Graduate Diploma of Applied Finance from the Securities Institute of Australia of which he was a member as a Fellow of Finance for many years and also has an undergraduate degree from Griffith University in International Business.  Owen's interests are tennis, running and his wife and two children.  He speaks fluent Chinese, first arriving in China in 1997.