Get set for a bumpy ride next year
Judging by the recent volatility in both share and property markets, the coming year could be difficult for investors who’ve been lulled into complacency by the healthy returns generated by the recovery from the global financial crisis. Whilst not as severe as the 1987 share market collapse, the GFC triggered sharp losses for investors in higher-risk property and share assets.
Government bailouts, steep reductions in official interest rates and quantitative easing cushioned the blow for investors by assisting the recovery of share and property markets around the world. The problem now is that with interest rates still near historical low levels and budgets still in deficit, governments and central banks are less able to minimise the impact on investors of the next downturn.
Even if world economic growth continues at current sound levels, Australian investors will have to adjust to tighter credit controls as well as proposed changes to negative gearing, capital gains and imputation credit tax arrangements. Higher capital gains tax bills and increased difficulty in obtaining loans will reduce the attractiveness of new investments.
The share market will also suffer from reduced demand for the higher-yielding fully franked dividend paying shares if the tax rules change. How much the proposed changes will affect the returns of individual investors depends on the composition of their portfolio. The more diversified the asset classes, the smaller the impact of any changes.
One reader pointed out that last week’s assumption of a tax-free pension fund’s investment of $1 million in Australian shares was unrealistic. For a pension fund capped in size at $1.6 million, that Australian shareholding would make up 62.5 per cent of fund assets. Very few retirees relying on their pension fund could afford the risks involved in such a large holding in the asset class. Most-risk balanced and growth funds don’t invest more than 30 to 35 per cent in Australian shares.
There are significant risks involved in putting all or most retirement assets in one basket. There’s no possibility of replacing lost assets by future savings and in many situations, there may not be the ability to sit out a downturn until asset values improve.
Given the uncertainty about future returns, investors needing to draw on their capital can reduce their risks by having enough cash or certain income to meet their needs for an extended period. In the context of market recoveries, a period of at least three years may be required for markets to return to previous levels.