Answer to chaos is to diversify

Bruce Brammall, The Australian, 24 April, 2022

24 April 3

Dumb decisions admission time – one of my earliest investment decisions was one of my stupidest.

It was 1993 and I was early-20s. I had some money set aside to pay off the last of my HECS university debt in about nine months’ time. If I paid it in a lump sum, I’d get a 15 per cent discount on the total debt. A great deal.

I stopped paying my HECS directly out of my salary and decided to invest the savings, hoping to make a little more on the 15 per cent discount I was already guaranteed of.

But where to put it for that nine months?

Being a young idiot, I thought I’d have a crack at investing. (First three mistakes made right here: failing to hold cash if an investment timeframe is less than two years, not getting advice and not understanding that I was a young idiot.)

I went searching, pre-internet days, and came up with a plan to invest it in a managed fund by Bankers’ Trust, now known as BT.

The fund’s returns had been awesome, so I filled out the paperwork and sent in my cheque. (Fourth mistake: chasing returns.)

BT was still living off its reputation from correctly picking the 1987 stockmarket crash and selling down ahead of time.

However, being a young idiot, the fund I chose was a BT bond fund.

For a long time, I’ve known that bond prices have an inverse relationship to interest rates. But in 1993, I had no clue.

When interest rates fall, bond prices rise. And Australian investors had just watched the Reserve Bank cut interest rates from 17 per cent to 4.75 per cent coming out of the “recession we had to have”. (Fifth mistake: not understanding what I was investing in.)

Hence why the fund had done so well.

Bonds also tend to move in anticipation of interest rates. Once they sense central banks will move up, investors start selling off bonds, causing prices to fall.

It was about then I was supposed to sell the fund to pay my HECS debt. But returns had been mediocre, though positive, so I decided to hold on to the fund and pay the HECS debt with other savings I’d diligently accrued. (Sixth mistake: Not sticking to the plan and taking a profit.)

Then bonds started tanking as the RBA interest rate increases became imminent, then actual. (Seventh mistake: Taking the advice of a young idiot to effectively combine all of the above mistakes into one final calamity.)

From memory, by the time I eventually sold, I think the investment had lost all gains and the entire 15 per cent that I’d made on my other savings by paying early.

(Let’s just take a second to note that BT, owned by Westpac, is on the chopping block and parts of the business are worth, essentially, nothing, according to Westpac. If you sense in me a little bit of schadenfreude for BT, you’d be right, though I totally accept they were my mistakes.)

Mistakes aplenty

All investors make mistakes. But all of the above mistakes are avoidable. (Even youthful stupidity, though many probably no longer have that as an excuse!)

This year, markets have proved they can change direction away from recent trends at short notice. In fact, all of the basic, major, asset classes have changed tack. Some quite viciously when compared to their historical averages.

Understanding what’s going on is important to being able to have contingencies.

Fixed interest, property and shares have all headed off in different directions, at different speeds, than their pre-Christmas trajectory.

Safety in bonds?

Normally, cautious investors look to bonds and fixed-interest investments for relative safety. Lower risk, lower return, is their general nature.

Bonds had done pretty well for many years while rates were falling, until the middle of 2021.

But, in January, fixed-interest investors said they no longer believed the Reserve Bank would hold rates at virtually zero until 2024, which the RBA  had claimed in May last year would be the case.

As a result, bond markets started selling off. It’s not just Australian fixed-interest investors. It’s a global shakeout, as central banks around the world start to lift rates from emergency lows for Covid.

The more defensive you are as an investor (I’m particularly talking to those with conservative super investors), the more you are likely to have a higher proportion of bonds in your portfolio.

But don’t panic. In all likelihood, your super fund will be diversified across other asset classes, including shares and property.

If concerned, seek advice.

Fixed home loans

Thought not specifically fixed-interest investment, fixed-rate home loans are related.

If you have a mortgage, have you considered fixing rates recently? There has been a spike in interest from property owners: “Should we fix interest rates before the Reserve Bank increases rates”.

Sadly, that ship has left port.

Last year, you could fix your home loan with an interest rate starting with a 2, in some cases even a 1.

Two-year fixed rate loans now start with a 3 and if you want to fix for three or more years, you’ll be paying in excess of 4 per cent.

If the Reserve Bank hadn’t yet moved interest rates, why has this occurred? Because fixed home-loan interest rates are based on expectations of what the average interest rate will be over that period.

If investors think the interest rate over the next three years will start at 2.5 per cent, but end at 5.5 per cent, then banks, investors or super funds providing the money for borrowers are going to want something north of 4 per cent.

I’m not saying fixing your mortgage now is a bad idea, because I’m not here to predict the average interest rate over the next two to five years.

But fixed rates are generally an insurance policy for home buyers fearful of rates rising beyond their capacity to pay. Over longer periods, you’ll probably do better with variable, as a general rule. 

Shares going … where?

Australia’s share markets have changed direction four times in four months. Seriously.

On January 4, markets had hit a new peak. But then started reacting to revised expectations on interest rates and fell. Near the end of January, investors thought they had over-reacted and started rising again.

Russia then lined up on the border with Ukraine and we had three to four weeks of uncertainty and global markets reacting by selling off. Eventually, war happened.

It’s not that share markets don’t like war. Studies have shown they generally do well in times of conflict. But they don’t like a long, protracted, lead-up. The uncertainty makes investors seek safer investments.

And, sure enough, as soon as war started in late February, markets started to climb again. They had certainty. Australia and its markets, which is a long way from the war zone, have actually outperformed major international markets.

In the home zone

Property markets don’t move as quickly as share markets, but they certainly seem to have turned a corner in parts of Australia.

Sydney and Melbourne property markets have recorded some negative returns in recent months, signalling the end of a bull run that started in late 2020.

Other metropolitan cities seem to still have some puff left in them.

But most experts now believe the easy, early, returns in this property cycle are behind investors.

Diversification “The Answer”

The contingency plan for market mayhem should almost always be diversification.

Being “all in” on shares, or property, or bonds, or cash, leaves you at the whim of market sentiment to that asset class.

Back in 1993, I should have stayed happy with getting probably 5 per cent interest on my cash for that nine months. That was the only “safe” thing to do when you are investing for a short period.

But even if there was a chance that I was going to turn it into a longer term investment (which there was), being diversified across asset classes would have been a far safer bet.

Bruce Brammall is both a financial adviser and mortgage broker and author of books including Debt Man Walking. E: bruce@brucebrammallfinancial.com.au.

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