Forget the show, stick to basics

To eager purchasers of the Model T Ford, Henry Ford reputedly said, “you can have any colour you like as long as it's black”. He knew that the introduction of low-cost motoring was a revolutionary development and that offering a selection of colours just added cost and was functionally irrelevant.

When making investment choices it is very easy to be distracted by matters which may attract a lot of debate, but functionally don’t create a better outcome in the longer term.

Financial advice is much like other professional services; if clients put their mind to it they could probably do a lot of it themselves. However, a little knowledge can be a dangerous thing and sometimes our intuition can be unhelpful when it comes to investment decisions.

A recent piece of research¹, which looked at the various determinants of investment outcomes, revealed five central elements that drive investment results. The research went on to rank the importance of those elements. Although the research was based on a lifetime of investing via KiwiSaver, I believe that the conclusions hold true for investments as a whole. It contained a few surprises as to which factors rank as most important.

Of the five factors the most influential was Asset Allocation (the portfolio split between bonds and shares). Whether asset allocation explains 70%, 80% or close to 100% of investors’ returns over time can be debated. However, there is no doubting that everything else ranks far behind. Unless your risk profile suggests otherwise, or you need to access your capital over the short to medium term, then ensuring that you have a reasonably high level of diversified exposure to listed shares is the best long-term investment decision you can make.

The next most powerful contributor to your outcome is your savings rate. In a low interest rate environment, where low yields are the norm, there is no substitute for savings. As long as you are not deeply indebted and you have your mortgage repayments under control, there is little danger and a lot to be gained by saving more.

The third contributor to the overall result was manager performance. This will surprise some people as it is often promoted as the first consideration. It turns out that a manager’s performance throughout the full investment cycle is the key, rather than just outperformance at certain points or in a single sector.

The research showed that fees ranked fourth. Whilst the cumulative impact of fees on your investment outcome is an important consideration it is meaningfully less than the value that can be added in the three previous categories.

The impact of the market cycle came in at fifth. This phenomenon was most recently demonstrated by those who were planning to retire in late 2007. This time marked the start of the Global Financial Crisis (GFC). In some cases, people saw their wealth dramatically reduce in what was to be their final year of work. In other cases, this created an opportunity to buy into the market for those who had not yet reached their retirement. In my view the asset allocation decision is seldom a ‘set and forget’ arrangement. It generally needs to be adjusted as your ability to accept investment risk reduces with age.

The study also examined the value that working with a qualified adviser can add to your situation. It concluded that just the process of helping the client set and maintain an appropriate asset allocation, rather than chopping and changing in a reactive manner, adds considerable value. This finding is supported by other studies that have measured this effect, the so called ‘Adviser Alpha’.^2,3 These studies suggest that the behavioural coaching value of a qualified financial adviser is worth and additional 1.5% per annum.

The research shows that, when it comes to advice and investment performance, it pays to focus on the factors that drive results, rather than be distracted by the ‘sideshows’ that can divert your attention.

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Peter Ashworth is a Principal of New Zealand Funds Management Limited, and is an Authorised Financial Adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily those of NZ Funds. His disclosure statements are available on request and free of charge.

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1. KiwiSaver Insight – Retirement decisions based on science not spin, van Wetering, P., NZ Funds, 2018.
2. Alpha, Beta, and Now Gamma, Blanchett, D. & Kaplan, P., September 2012.
3. Behavioural Alpha: The True Power of Financial Advice, Crosby, D., August 2015.

First published in the Otago Daily Times on 15 April 2019, as 'Forget the show, stick to basics.'