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Preparing for the ups-and-downs of 2017

After the rollercoaster of investment emotions that was 2016, investors have been cautiously embracing a more upbeat feeling across markets so far this year.

Perhaps it is wishful thinking, but it seems many pundits and punters alike are growing comfortable with the fact that, although the world looks a lot different to what it did a year ago, it’s not all doom and gloom where investing is concerned.

Although a market rally can certainly buoy hopes for a more stable year, we should remember that last year was certainly no slouch for returns, despite medium-to-long-term forecasting pointing to market returns lower than historical averages, underpinned by slowing global economic growth.

In fact, the broad Australian sharemarket returned more than 11% last year, despite early concerns that China’s slowing economic growth and softer commodities prices would hurt the local economy.

Resilience is conditional

With that example in mind, it can be comforting to think that our investments might be more resilient than expected. Diversification and discipline are essential to 'future proofing' a portfolio, allowing it to weather oscillating markets by being more resilient in the face of volatility.

Diversification allows investors to spread risk and avoid a catastrophic hit to their portfolio if they are over-exposed to a single company, sector or market that tumbles. Having exposure to multiple countries, industry sectors, varying market caps and asset classes (e.g. equities and fixed income) gives portfolios a better chance at carrying on should only a portion of its holdings go through a cycle of underperformance, or loss.

While diversification acts as a shock absorber for a portfolio, discipline is the key to letting diversification do its job of managing risk. By avoiding the temptation to follow market trends, either by selling an asset when its value falls, or buying an asset that’s on an upward march, investors can remove perhaps the riskiest factor that can hammer potential returns: human behaviour.

Human behaviour, particularly fear and temptation, are what can drive investors to make ill-considered decisions in times of market fluctuation. We saw this last year when many investors sought to flee UK equities ahead of the Brexit vote, only to miss out on a fairly quick recovery in that market. An investor with a broad exposure to the British sharemarket would have likely been better off gritting their teeth through the tumult and seeing it through to the other side.

Vanguard’s global CEO, Bill McNabb, discussed this recently with The Evidence-Based Investor, outlining how Vanguard approaches market flashpoints like Brexit in terms of understanding risk, rather than trying to work out trading strategies to minimise damage or maximise opportunity.

In a recent letter to investors, the full version of which is featured below, McNabb also outlined the need for investors to be prepared for future volatility, saying that surprises should be expected in 2017. Although Vanguard isn’t in the habit of offering ‘hot tips’ for investors, McNabb outlined in his letter these four pieces of advice to help investors navigate uncertainty and set themselves up for investment success.

Valley Forge, Pennsylvania

9 January 2017

As we begin 2017, I'm struck by the questions we've been receiving from our investors. Never before — not even during the Global Financial Crisis — have investors come to us with such specific concerns about the movements of the markets and governments around the world.

We're living in unprecedented times, so we certainly can't predict what this year will bring. And if you know Vanguard, you should know not to expect ‘hot tips’ or ‘sure bets’ from us either. But I do have four suggestions that I believe can help investors reach their goals.

1. Prepare for uncertainty. Several political and economic events caught observers by surprise in 2016, including the results of the Brexit vote in the United Kingdom, the presidential election in the United States and the federal election in Australia. Markets respond to surprises with volatility, and we expect more surprises in 2017. With a new US administration comes the potential for changes to policies that affect investors. Some may be beneficial; some may trigger market volatility. The best approach in any environment is to maintain a long-term perspective and a balanced and diversified portfolio.

2. Save more. In addition to potential near-term volatility, we expect the equity and bond markets to produce lower returns in the next ten years than they have over the past several decades. This will place the burden on investors to save more. Saving more is an asymmetrical proposition: If you don't save enough and the markets don't assist you, there's nothing you can do. If you over-save and do well, great – you can retire a few years earlier.

3. Safeguard your assets. As the threat of cybercrime continues to grow, we work hard to protect our clients' assets and data. But investors must be aware of the risks and take precautions too.

4. Stay well-informed. Great investors understand how all the pieces fit together. Become familiar with all the components of your portfolio and know the role that each one plays in your investment plan. Stay abreast of the markets and economy but don't be driven by their movements. I realise it sounds paradoxical to say, "Stay current but resist the urge to act." But that's exactly what you should do.

Here's to a prosperous 2017.

William McNabb III, Chairman and Chief Executive Officer, The Vanguard Group, Inc.

 

Robin Bowerman is Head of Market Strategy and Communications at Vanguard Australia. This article is general information and does not consider the circumstances of any individual. Vanguard is a sponsor of Cuffelinks.

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