Why Investors Should Heed, But Not Act On, Forecasts
It's that time of year again - our inboxes are now being deluged with a variety of weird and wonderful predictions for sharemarkets and economies in the coming year.
These annual forecasts typically include sophisticated thinking that points to weighty outcomes for investment portfolios. These can naturally lead investors to consider changing up their strategies to shelter from or harness the coming year's conditions.
However, the real value these forecasts provide is not in convincing investors to chop and change their strategy - which can be detrimental to portfolio performance - but to provide realistic expectations for how a portfolio might perform in future market conditions.
With that in mind, we might look to Vanguard's outlook for economies and markets in 2017, which can give investors an understanding of what to expect from their portfolios, not just next year, but over the long term.
First and foremost, investors should expect the low economic growth and modest market returns of 2016 to continue in 2017 and beyond, according to the 2017 Vanguard economic and market outlook paper.
Vanguard Global Chief Economist, Joseph Davis, Ph.D, says there is a persistent myth that global economic growth is stagnating, but that Vanguard's analyses points more to the world digesting a long-term trend of lower, but more sustainable, economic growth.
“The extremes that we are bombarded with each and every day-negative income rates, Brexit, income inequality-may seem like isolated events, but we know that they are inextricably linked by these secular forces,” Mr Davis said.
“Perhaps most significantly, we are focused on the changing tides of technology and a gig economy. This is a significant disruptor, yet the global economy has a remarkable ability to adapt to change. We anticipate muted, but enduring and positive economic growth in the years ahead.”
So what exactly does this mean for an investor's portfolio as the world economy keeps ticking over?
Vanguard Head of Investment Strategy Group in Asia-Pacific, Jeffrey Johnson, says investors should be realistic but not pessimistic about what the sustained low-growth environment might mean for portfolio returns, both in the coming year and over the next decade.
“Our proprietary Vanguard Capital Markets Model has simulated returns of between 6-9 per cent per annum over 10 years, for a portfolio made up of 50 per cent Australian shares and 50 per cent unhedged international, developed markets shares ex-Australia. This is down from the 10-year forecast last year of 7-10 per cent annualised returns Vanguard made in 2015, and down from Vanguard's forecast of 9-12 per cent from 2010,” Mr Johnson said.
“On the fixed income front, a globally diversified bond portfolio is forecast to return around 1-3 per cent per annum over the next decade. Although these returns are certainly low, investors should remember that bonds aren't just useful for deriving income, they are also invaluable for helping to balance the risks inherent in equity investments.”
What these long-term forecasts ultimately tell us is that we should continue to expect returns lower than what we've seen in the years since the GFC. Although an investor's first instinct might be to shake-up their asset allocation in the hunt for higher returns, it's critical that they recognise that pursuing higher returns means taking on more risk. This brings us back to portfolio fundamentals - that is, that an investor's goals, their time horizon to meet those goals and their tolerance for risk should continue to underpin their portfolio's make-up.
Making changes to your portfolio based on annual market forecasts - particularly if you are investing with a long time-horizon, as is the case with many self-managed super funds - can do more harm than good, moving a portfolio away from its risk settings, and putting it further from meeting its objective.
That's why it is critical for investors stick to their long-term plan, use market forecasts like these to set their expectations of investment performance in future, and brace themselves for the inevitable highs and lows of investment markets.
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.