Investments can be volatile

Volatility is a term often used to describe fluctuations in returns. It is also a way of measuring risk. You might have noticed the value of some investments such as shares and property ‘bounce’ up and down more often than others such as fixed interest or cash. This is because different investments carry different levels of risk and return.

Figure 1 – Range of one year returns
One year returns from 31 March 1992 to 31 March 2012

Source: Perpetual and Datastream.

Figure 1 shows the range of returns for different investment types or asset classes. You can see that, over the past 20 years, annual returns for property have ranged from a high of 43% to a low of -58%. On the other hand, returns for cash have only varied from 10% to 3%.There is a higher level of risk associated with investments such as property, and to earn the high returns you need to withstand the possible lows.

Investment returns can vary

The variation in returns is often because different investments perform differently in various economic conditions. This is illustrated in Figure 2 where you can see that over a long period there is no one asset class that consistently outperforms the other asset classes each year. Over the 20 year period, Australian shares have produced the highest return eight times, international shares five times, property four times, Australian bonds twice and cash once. Likewise, over the 20 year period Australian shares have produced the lowest returns of the asset classes twice, international shares six times, listed property three times, Australian bonds five times and cash four times. It is important to note that choosing a different time period would not necessarily show the same pattern of returns and equally, the results may not be repeated in the future.

Figure 2 – How different asset classes have performed over time
Annual returns from 30 June 1991 to 30 June 2011

Source: Datastream.
(a) Blended All Ordinaries Index. Post 31/3/2000 S&P/ASX All Ordinaries Accumulation Index. Prior to 31/3/2000 ASX All Ordinaries Accumulation Index. (b) MSCI World ex Australia Accumulation Index $A. (c) Blended Property Trusts Accumulation Index. Post 30/6/2002 S&P/ASX 300 Property Trusts Accumulation Index. Between 1/4/2000 and 30/6/2002 S&P/ASX 200 Property Accumulation Index. Prior to 1/4/2000 ASX Property Trusts Accumulation Index. (d) UBSA Composite Bond Index. (e) UBSA Bank Bill Index.

Having a diversified portfolio, containing a mix of asset classes such as Australian and international shares, property, fixed interest and cash, can mean that being in the best performing asset class offsets being in the worst performing asset class over any time period.

Diversification can smooth the ride
Figure 3 shows that while the performance of this range of asset classes has varied widely over the past 20 years, the average return (which assumes an equal weight in each asset class) provided a much smoother result.

 
Figure 3 – Diversification can smooth the ride
Annual returns from 30 June 1990 to 30 June 2010

Source: Datastream.
(a) Blended All Ordinaries Index. Post 31/3/2000 S&P/ASX All Ordinaries Accumulation Index. Prior to 31/3/2000 ASX All Ordinaries Accumulation Index. (b) MSCI World ex Australia Accumulation Index $A. (c) Blended Property Trusts Accumulation Index. Post 30/6/2002 S&P/ASX 300 Property Trusts Accumulation Index. Between 1/4/2000 and 30/6/2002 S&P/ASX 200 Property Accumulation Index. Prior to 1/4/2000 ASX Property Trusts Accumulation Index. (d) UBSA Composite Bond Index. (e) UBSA Bank Bill Index.

The benefits of diversification are clear
History shows that the best way to reduce risk and smooth out returns is to ‘not put all your eggs in one basket’ - hold a diversified portfolio, including growth and defensive assets over the long term. By placing your money in a number of asset classes (not necessarily in equal weight) the good performance of one investment can offset the bad.

Perpetual offers a range of diversified investment funds. To find out more, speak to your adviser or call Investor Services on 1800 022 033.