Investments

15 April 2024

By Peter Moussa

The types of investments selected and the weighting each asset class is given are important considerations when constructing an investment portfolio, as is a sound understanding of your risk appetite and how each investment fits into that framework.

Most people know options like an interest-bearing cash account or term deposit. While these offer a safe return on investment with no volatility on the initial funds invested, they generally offer a return that is close to the prevailing inflation rate, which means savings growth is low relative to increases in the cost of living.

This is because the cash rate is set by central banks based on current and expected changes in inflation, which indirectly impacts returns received on cash and other investments. This low rate of real return is why many investors turn to alternative assets to boost their returns.

Investors branching out typically keep enough aside in a cash account or term deposit for any short-term needs (less than 12 months). For anything longer, there are several options to consider, each with their own ideal time frames and depending on an investor’s expectation for return vs risk.

Low volatility assets such as floating rate notes may be used for funds needed in the shorter term, and higher volatility assets that offer the potential for the best long term returns such as shares could be considered for funds invested over longer timeframes.

Floating rate notes are relatively low in volatility and work by offering a margin above the expected cash rate. The risk of loss on capital is subject to the issuer of the bond remaining solvent, which is why corporations with strong credit ratings (For example, the Australian big 4 banks) are often selected. The margin above the benchmark rate can vary between 50bps to 400bps, depending on the issuer and the tier of debt chosen. For example, a floating note that offers 200bps (2%) above the benchmark rate today of 4.35%)[1] would pay the investor a 6.35%pa return. Investors normally use these for funds that may be needed over the next 1 to 5 years.

Fixed rate bonds are also considered to be relatively low in volatility, however in addition to credit risk they also carry interest rate risk. These bonds are issued at 100 when the bond is first issued and are redeemed at 100 on the maturity date (assuming no default), which is typically 5 to 10 years from the issuance date.

This means that if the bond is held to maturity the investor will receive their initial investment back in full in addition to the interest earned from the bond. However, as we know sometimes investors need access to capital before the bond matures and, in this case, investors may buy or sell the bond before maturity, however, they are subject to market volatility which amongst other things, is determined by the likelihood of default of the issuer and changes to interest rates at the time.

Also, the interest rate component of the price creates both risks and opportunities, if interest rates move lower, the bond price moves up. This is because new bonds that are issued when rates move lower generally offer a lower yield, making older bond more attractive. The reverse is also true if interest rate move up, the bond price moves lower. These usually pay a return similar to floating bonds, but the key difference is that the coupon is fixed, meaning they are normally preferred if an investor feels that interest rates are likely to move lower over the coming years. Investors typically use these for funds needed in the next 5 to 10 years. High quality bonds in June 2024 were paying around 6%pa.

Equities (stocks) are considered to the be the most volatile over the short term but can potentially offer a relatively higher return over the long term. Historically they have outperformed other assets including property. For funds that can be put aside for a longer time horizon, investors can consider equities as well as tools such as margin loans that allow investors to borrow and invest in equities just like many people do with property. This is because a longer time frame allows investors to weather market downturn and capitalise on long term growth potential. Investors should also consider their comfort with market swings and the ability to remain investing during turbulent times. The long term average return on the US S&P500 Index over the last 40 years was 12%pa, according to Bloomberg.

Commodities, such as gold or oil, can be a hedge against inflation and a diversifier in a portfolio. They tend to be uncorrelated to stocks and bonds. Investors can gain access to commodities and miners through several listed exchange traded funds. Investors may consider these assets to reduce overall portfolio volatility during periods of higher inflation.

Real estate is a very popular long term investment vehicle, normally held for over 10 years. However, investors need to consider the costs involved to buy and sell a property is a lot higher than shares given agent costs, stamp duty as well as ongoing maintenance costs. Property can often go through long periods of flat prices. Over the long term they have created wealth for many investors, however, as an asset class, it has historically underperformed equities.

According to Bloomberg, over the past 40 years Australian property has returned an average annual return of 8.8%pa compared to, Australian equities at 10.3%pa and US equities 12.1%pa.

When choosing which asset classes to invest in, a well-diversified portfolio is typically recommended. This is because by holding more uncorrelated assets, the overall portfolio volatility decreases. This can help improve the overall portfolio return while decreasing volatility. So, while holding as many uncorrelated investments as possible is generally a good idea, investors also need to consider their own risk tolerance and investment time horizons when making investment decisions.

Long term returns

As of April 2024, $10k invested in 1984 is now worth:

Asset class       Todays value    Average return (pa)

Cash:                    $120,727            6.4%

Bonds                   $206,579            7.9%

AU property       $296,283            8.8%

ASX200                $498,757            10.3%

S&P500               $962,560            12.1%

*ASX200 and S&P500 represent AU and US share respectively. Source Bloomberg as of April 2024  - The annual return shown is the effective annual compound rate of return. Past performance is not a reliable indicator or guarantee of future performance.

Exposure can be gained to either of these indices through an exchange traded fund utlising the nabtrade trading platform.

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

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The information contained in this article is believed to be reliable as at April 2024 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

©2024 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.

[1] Source: Bloomberg as of April 2024

Investments