How often would you head to the supermarket without a shopping list, walking up and down each aisle only filling your shopping trolley with items that are running bare on the shelves?

Of course, this is not a rational way to shop.

Armed with your shopping list – a written plan based on what you need, a visit to the supermarket is a simple exercise to replace what you have consumed and to have available what you need until your next visit.

If there is a special event like a dinner party or guests staying over, you may buy additional items to accommodate this.

However, this is based on the rational behaviour of other shoppers and the supermarket having constant supply. As we have seen, this rational assumption falls over when the herd mentality of irrational shoppers takes over.

Planning for irrational events is where the importance of financial advice is at its most valuable point.

Your financial adviser helps you to set your goals and then devises a strategy to handle the inevitable bumps along the way, based on experience, expertise and with historical understanding of previous bumps.

Specifically, a financial adviser incorporates the following elements to ensure your financial plan remains on track:

  1. Understanding your individual consumption needs – cost of living
  2. Personalising your investment portfolio – based on your risk appetite

Creating a budget is much like your shopping list. You identify the cost of everything you plan to consume.

Knowing that your desired income will be paid to you each fortnight means that you don’t have to ‘stash’ cash around your home to pay for future expenses.

Your financial plan will have a strategy to ensure your income is feasible for your life expectancy and, crucially, that it comes from a source that is not subject to the bumps of short-term losses.

Accordingly, the extent of expected short-term losses is managed via the coexistence of Defensive assets (such as Cash and Fixed Interest) alongside Growth assets (such as Shares and Property) in your portfolio.

Each super fund provides guidance on the risk of each investment option by stating its risk level (low, medium or high), a suggested investment timeframe and the expected frequency of negative annual returns.

A financial adviser may recommend a combination several investment options, in a strategy called the ‘bucket approach’.

Essentially, this strategy involves investing enough in Defensive assets (an investment class with low volatility) to pay for income requirements over a long enough period to cover the expected negative periods of your investment portfolio. If you planning additional expenses like a holiday, new car or home renovations, these too can be accommodated within the Defensive assets.

The Global Financial Crisis (GFC) of 2008 highlighted how a bucket approach to segmenting retirement income could assist in ensuring that volatile Growth investments were not sold at a loss to provide for income needs.

The following graphs show the investment performance of two diversified investment options with different exposures to Growth and Defensive investments:

Balanced: 70% Growth & 30% Defensive

Conservative Balanced: 50% Growth & 50% Defensive

Source:

https://www.unisuper.com.au/investments/investment-options-and-performance/super-performance-and-option-holdings/Balanced

https://www.unisuper.com.au/investments/investment-options-and-performance/super-performance-and-option-holdings/conservative-balanced

2 These graphs show the growth of $10,000 invested in these options over the period illustrated, that is 2004 to 2020, net of investment expenses and fund taxes but gross of account-based fees. No adjustments have been made to reflect the impact of inflation.

As shown in the graphs, the ‘Balanced’ option took 4 years to recover from GFC market losses (2008 until 2012), while the ‘Conservative Balanced’ investment option took only 2 years to recover (2008 until 2010).

The rational point to note is that if you have sufficient Defensive investments to cover the expected timeframe of negative periods of your investment portfolio, then you are not forced to sell investments during the negative ‘bump’ periods. In this way you will avoid selling investments at the worst time – that is during negative periods.

It is also important to understand that the media is reporting the returns on the quoted market, not on individual portfolios. So, for example, if we look at a quoted market such as the S&P ASX 200 index, we see that since the start of 2020 it has fallen 4.6%.

Year to date performance of ASX 200 to 4 March

Source: https://investmentcentre.moneymanagement.com.au/news/7462164/how-much-further-can-the-asx-200-fall?

And if you were 100% invested the S&P ASX 200 index, this is the return you would have experienced.

However, the returns on diversified portfolios that contain a mixture of Growth and Defensive investments have experienced very different rates of return, as seen in the graph below.

Source: https://www.unisuper.com.au/investments/investment-options-and-performance

To return to my opening comment, your individualised portfolios have been created with your financial adviser with your goals and your needs front and centre. Your blend of Defensive and Growth assets takes into account the inevitable financial bumps that occur. COVID-19 is a bump, perhaps a big bump, and one that we all would have preferred was not happening. The rational perspective is to view it for what it is, to not panic and to hold to the financial plan.

If you would like to discuss your financial plan, contact Advice SA for an appointment.

Mark Bastiaans is an Authorised Representative #296627 of Guideway Financial Services Pty Ltd ABN 46 156 498 538 AFSL 420367.

The information provided above contains general advice that does not take into account your financial situation, specific needs or objectives and is not intended to be personal financial advice and should not be relied upon without written advice from Guideway Financial Services Pty Ltd.