As featured in the Herald Sun – Friday 12th August 2016.
By David McCulloch – Market educator and consultant to Share Wealth Systems
Every investing plan must have an objective. Without an objective how do you know what you’re aiming for? So what is a suitable objective given the market that you are primarily going to invest in? Great question.
A long term goal is usually measured as a percentage return, and it does need to be a longer term goal because the market conditions can change quite dramatically over a shorter time frame. As an example the ASX200 has typically returned around 8% per annum inclusive of dividends over the longer term. If you are happy with an 8 % return the simplest thing to do would be to buy an index fund, however as we’ve seen there are times that this might make sense and times when it might not.
The goal of every self-directed investor should be to outperform the index and in my opinion I believe it’s possible to do providing you know what to look for, how to implement and how to manage each holding in your portfolio. First of all you need to make sure that the objective you set is realistic given your current experience, your investing approach and the amount of time you have available. Typically your objective should be benchmarked or compared to the main index of the market you are investing in. For Australian investors that might be the ASX200 and for our friends in the USA it might be the SP500.
A general rule of thumb might be that your objective is somewhere between 1.5 -2 times the annual return of the respective benchmark. So in the case of the ASX200 a reasonable longer term objective might be between 12-16%. Now remember that is an average and sometimes the actual results might be higher or lower. What matters at this point when starting out is that you have a target to begin with. Your plan will be dynamic and that means that it will be open to change along the way, so some fine tuning is ok as your experience and comfort level grows.
Whenever we think about return, we also need to think about the other side of the equation, which is risk. How much risk are you willing to take on in order to achieve your return objectives? It makes sense that once you reach this limit that action be taken to slow things down, and stem further potential losses. You will also need to make sure that the level of risk taken is sufficient to achieve the desired return objectives. Risk and return are highly correlated, and looking for a high return typically means taking on more risk. Lower return objectives generally require less risk. This means that you’ll need to establish what is a suitable level of risk for you, in accordance with your investing goals. The first rule of investing is the protection of capital. The second rule is not to forget the first rule. Next week I’ll provide some tips for measuring risk in relation to your investment return objectives.
David McCulloch is a market educator and consultant to Share Wealth Systems.