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Lessons from the NZ shares returns

Over the five years from 1 October 2008 to 30 September 2013, the best performing SuperLife investment Pool was NZ shares. This was despite the 20% market down-turn in the first six months (highlighted by the circle in chart 1). The value of $100 invested in NZ shares on 1 October 2008, including the accumulation of dividends grew to nearly $175 over the five-year period.

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Over the five-year period, the average return for NZ shares was 11.6% a year, after-fees and after-tax (at the highest PIR rate). The 11.6% a year compares to the returns of the other sectors of:

Net returns.png

The 11.6% a year is above what we would normally expect and reflects what happened in the market. But on 1 October 2008, we were not to know that NZ shares would be the best option for the following five years. And even if we thought it might be, would we have had the confidence to invest in NZ shares at the time?

At the start of the 2008/2013 period, we were experiencing the continued fall-out from the sub-prime mortgage crisis and the beginning of the GFC (global financial crisis). Both of these events gave rise to a large decline in the global and NZ share markets in the 2007/2008 year (see chart 3). The net returns for the 12 months to 1 October 2008 (i.e. the period immediately prior to the last five years), for each of the
major types of assets the after-fee and after-tax returns were:

Net returns 2.png

The above highlights the impact of the sub-prime crisis and the GFC; sharemarkets fell and bond yields fell (which meant that bond prices rose). Cash rates also initially rose. In 2008, the “better” returns were being made on the cash and bond investments.

We suspect, given that at 1 October 2008 the sharemarkets were down 20%, many investors (probably most) may have felt uncomfortable investing in NZ shares and might have been tempted to reduce any exposure they had to shares. It might have been hard for many to make a decision to keep NZ shares, let alone increase them.

But the annual NZ sharemarket return to 1 October 2008 has to be put in the context of the longer term returns. Chart 4 shows the annual after-fees and after-tax returns from NZ shares over the last ten years.

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Chart 4 highlights that while the 2007/08 year was significantly negative, it was an isolated period over the ten years.

What can we observe and learn from the recent NZ share experience?

What the last ten years highlights is that:

  • if you invest in shares, at some point, the value of your portfolio will decline (see the 2007/2008 year) (chart 2 and 4)
  • if the market goes down 20%, it might still go down further before it starts to recover (see the end of the 2008 year) i.e. the start of Chart 1); and
  • markets ultimately recover and so a diversified share portfolio is expected to recover (see Chart 1). It is always a question of "how long will it take" and this is not known.

What the above means is that investors should probably consider in advance of a decline, what they would do if the market suddenly went down (or up), as it did in the 2007/2008 period and not wait for it to happen and then react. Making investment decisions at the time the market is in turmoil is challenging because of emotion and can lead to poor decisions.

Given we know markets go up and down, it is important that when we decide to invest in shares, we do so because we wish to capture the expected higher average return over the long-term, and we are willing to experience the potential negative extremes that could occur short-term, without panicking.

There are a lot of clichés used when it comes to investing in shares. A common one is, “it’s about time in the market and not timing the market”. This is typically used when the markets have just gone down and investors are nervous. We don’t think it is about time in the market, or timing the market; it’s more about being willing, if you are in the market when it goes down, to accept it and making sure that you have other investments (like some cash) so you are not financially embarrassed.

Investors looking at the accumulation of assets over the long-term, appreciate that they should have a diversified portfolio that has exposure to all the asset classes. Exposure to shares helps to achieve an overall return that will generally exceed inflation and so preserve the purchasing value of their investments in the future. It is normally about managing risk and not trying to pick winners.

The outlook - the next 5 years

At 1 October 2008, we did not know that NZ shares would be the best option for the next five years. Likewise, we do not know what will be the best option for the next five years to 2018. We believe that it is not possible to guess with consistency and accuracy, what will happen in the immediate future or in any period. This is one of the reasons why we suggest investors adopt the bucket approach to investing and allocate their investment capital to the sectors (buckets) based on when they will spend their money.

Expenditure in Bucket
Next 0 to 3 years Cash
3 to 10/12 years Bonds
10/12 years plus Shares/property

The combination of the three buckets gives you your overall investment strategy and will reflect when you will spend your money. Under this approach, those nearing the time they will start spending (e.g. at retirement), will have more cash and bonds and less shares and property. In contrast, those still a long way off retirement will have more shares and property and less cash and bonds, assuming that they are willing to have the ups and downs and are focused on the long-term.