You are probably sick and tired of hearing me preach about not expecting a repeat of the past few years when it comes to market performance.
Let's look at an example illustrating the folly of projecting the past. Lower bond yields mean positive returns.
US long bonds are currently trading around 4.5 percent. They have given returns of just over 10 percent a year for the past 25 years. If you expect more of the same over the next 12 to 15 years to retirement, you would be assuming that bond rates will fall to zero by then.
Yes, zero. I would say that this must certainly give US yields a fair chance of being higher than where they are now at some point in the future.
To extrapolate past returns can actually border on being nonsensical at times.
Recent asset management surveys reveal that the average retirement fund manager has delivered somewhere around 35 percent for the 12 months to October, and over 20 percent for the past three and five years.
The very human tendency to project the familiar and assume that it is indicative of the future came home to me when I was playing around with a retirement planning tool.
This planning tool required that one enters expected returns for the different asset classes until retirement.
As my fingers hovered above the keyboard, I realised that amid the wonderful bull run we have seen in our equity market, I have actually forgotten what long-term real return levels have been.
Let us do a reality check on real returns achieved in the South African market over the past 104 years. That is long term enough for me.
South African equities tend to do 6.8 percent better than inflation (we have seen a lot more in recent years), with bonds beating inflation by 1.7 percent and cash by 0.9 percent.
If you believe that we will stay within the inflation target range, we can expect long-term returns going forward of 13 percent, eight percent, and seven percent for equities, bonds and cash respectively. And guess what inflation was ... a mere 4.9 percent.
Looking back over the past century, it is astonishing just how abnormal the decades of the 1970s and 1980s were in terms of higher inflation, subsequent higher interest rates, and resultant lower real returns for shares in the decades to follow.
What can we learn from this? We have started to return to a more normal inflation environment.
While we can expect equities to be more volatile and for exuberant returns to waiver from time to time, the long-term growth prospect of equities affirms my view of last week - when you get worried about the risk in the growth assets in your portfolio, notably equities, don't sell out too easily.
Rather, divert the cash flows to more defensive assets.
If you do not have that option, look at switching a portion into more defensive shares or funds.
These could include funds with a value approach, dividend-yielding funds, flexible or balanced funds.
Given all this sobering talk about the past, what would be my dream share for 2006? The one I'd love to find in my Chritmas stocking?
Here are some of the principles I'd apply when shopping for shares for 2006:
- Firstly, I always prefer to invest in things I understand, even if I only do so after someone has explained them. Next year will be no different.
- Secondly, I like to look where the crowds are not looking - I have a natural aversion for the latest hot thing in the stock market. Pity that does not extend to my love of technology and gadgets. Sometimes at my peril, but there it is.
If you take a good look, you will find some lagging sectors and shares.
- Thirdly, I love dividends. They are tax free and honest. Companies that pay out dividends rather than pretend to find great acquisitions in order to build their power base get my vote.
Then, if the charts look good, I may take a closer look regardless!
On that note, I wish you happy shopping for your 2006 portfolio!