The following table shows how asset classes have performed over the 10 years to 31 December 2012 and is fairly typically of the type of table used by the popular media such as newspapers:
These types of tables, whilst providing a useful snapshot, should be viewed with caution. Investors actually receive in their pocket after tax returns in Australian dollars. This table shows pre tax returns and the international component has not been adjusted to reflect exchange rate gains or losses.
Exchange rates are important, the international shares performance of 6% is measured in local currency, in other words UK investments are measured in pound terms without any adjustment for exchange rates. This is not all that useful if you are planning on retiring in Australia because you are going to need Australian dollars to spend not British Pounds. Given the strength of the Australian dollar over the last ten years this would adversely impact the returns quite considerably from international shares from the amount disclosed.
The returns given above are also before taxes and fees (except superannuation) which can impact the investment decision quite considerably. The effect of imputation credits may increase the return from Australian shares by up to 1.5%.
Asset Classes Characteristics
Cash is the least volatile and theoretically risk free. However due to the insidious impact of inflation cash is arguably not risk free at all.
Fixed interest/bonds is more volatile than cash, it offers no or limited capital growth prospects and a regular income stream.
Property includes direct property investments like your house
Australian listed investments includes REIT investments which value fluctuate in accordance with the underlying property fundamentals as well as the broader share market volatility.
Shares are securities that offer ownership in a company and the opportunity for significant capital growth (or loss!). The value of the shares fluctuates with the company’s results and prospects as well as the broader economic and industry conditions. International shares have the additional risk of exchange movements.
So what asset classes are the best investment?
The best asset class allocation depends on the investor and their individual circumstance.
The table above gives investors some idea of the relative ranking of different asset classes in terms of the total potential return available but that is about all. By its self the table tells an informed, astute investor very little about which asset classes to invest in.
Risk and return go hand in hand and the table reveals nothing about the relative risks of each asset class. Shares are much more volatile and risky investment than say real estate (the ASX lost 39% of its value in the 2008 GFC crisis – ouch). The correlation of different asset classes is equally important, negatively correlated assets are worth their weight in gold in a portfolio and the above table sheds no light on these relationships. Taxes and costs have also been demonstrated to have a key if not the key impact on portfolio’s long term performance and the percentages in the above table are all pre tax and expenses.
Lastly the above amounts are historical returns and there is no rule written in stone that past returns are a reliable predictor of future returns.
The best asset allocation for an individual investor is the one that makes you the most amount of money with the least amount of risk and can only be ascertained by using more information than just the relative performance of various asset classes before tax and costs.