The long view
Today's Finance and Wealth figures from the ABS showed that Australians have been enjoying unprecedented levels of household wealth, perhaps even making Aussie households the richest in the world.
That many don't feel this way in part reflects that household wealth is often largely tied up in illiquid assets, such as the family home (real estate) and superannuation (pension), while there is now more than $1.1 trillion sitting in currency and deposits (cash), which doesn't earn a great deal of income in today's lower interest rate environment.
Another great speech today from the Reserve Bank's Dr. Kohler provided some handy pointers and context for people in this situation.
Firstly, it's important to take a long run view: over time the stock market has generated considerably higher returns than other investment options such as bonds or cash, notes the RBA.
That's as should be expected, as the cumulative returns from productive enterprise and human endeavour should outstrip the returns from other asset classes over time.
That's as should be expected, as the cumulative returns from productive enterprise and human endeavour should outstrip the returns from other asset classes over time.
Secondly, investors need to consider total returns, being both share prices and the dividend income.
Total return indices have quietly compounded away from an indexed base of 100 to somewhere in the millions over the past century, despite the volatility along the way.
Stock prices fell by about 50 per cent through the financial crisis, for example, so education, diversification, and a long run view are all important.
The RBA pointed out how the various sectors have delivered remarkably similar returns.
(It's worth noting that that you can get some very different results here depending upon the timeframe and the component parts.
For example, if you strip out the industrials index and map it against the All Ordinaries, real estate trusts, and resources indices since financial deregulation, you will see a significant cumulative difference.
For example, if you strip out the industrials index and map it against the All Ordinaries, real estate trusts, and resources indices since financial deregulation, you will see a significant cumulative difference.
Resources stocks can be volatile, exposed to commodity prices, capital intensive, and saddled with debt.
But the point is a fair one).
Although many have bemoaned returns from the Aussie stock market in recent years, Australia is a bit different from some other countries in that the returns from dividends (income) tend to be considerably higher than the global average, and therefore the capital gains (growth) tend to be correspondingly lower.
This is partly due to franking credits in Australia, which have been around since 1987, although unsurprisingly the Labor Party is eyeing these up too.
This is potentially very handy news for prospective retirees, provided that they have familiarised themselves with the above point on volatility above and can manage the risks accordingly.
Policies in the US have driven valuations high through this cycle - extraordinarily high in certain cases - reflected in the outperformance above.
But trees don't grow to the sky, and mean reversion could hardly be unexpected now that the Federal Reserve's tightening is well underway.
Valuations in Australia have generally speaking tracked far closer to their long run average of late, while recognising that PE ratios are a limited metric (and to be prudent we might also choose to acknowledge record high mining profits here).
In the short run the market may be a 'voting machine', but in the long run company earnings are the fundamental driver of valuations.
Terrific stuff once again from the RBA.
From my reading, here were 5 key takeaway points from the speech:
-equities have comfortably outperformed bonds and cash over the long run
-equities can be volatile, so some diversification is likely to be smart
-Australia's indices are bank heavy, and the 10 largest companies make up almost half of the total exchange by value (refer to the preceding point)
-many of our largest companies have been around for a very long time, but the industry composition of the index has shifted around quite dramatically over time (once again emphasising the diversification point)
-most returns in Aussie stock markets since in recent decades have come from income, not capital growth
While many companies have been around for the long haul, all companies ultimately have a life cycle - they are born, they live, and they die (or they merge, or get taken over) - so owning a broad cross-section of the index is likely to be less risky than owning individual stocks for most average investors.
Of course, everyone's circumstances are different, and therefore please note that this is not financial advice!
