Avoid the most common sharemarket trap

23 July 2018 | Investment principles

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Perhaps the most common trap for share investors is to concentrate too much on the daily movements in share prices.

This can give investors a misleading impression of their investment performance and encourage them to overreact to short-term market shifts. In turn, this can lead to following the, often emotionally-driven, investment herd in and out of the market – often at the wrong times.

By focussing on the daily ups and downs of share prices, investors may overlook the rewards from compounding returns (as returns are earned on past returns) and from taking a disciplined, non-emotional and long-term approach to investing.

An effective way to help block out the distraction of daily share price movements is to always keep in mind that there are two sides to sharemarket returns: capital gains (or losses) and dividends.

Once reinvested dividends are taken into account, the performance of the Australian sharemarket over the past decade looks much stronger – without considering dividend franking.

The S&P/ASX 200 (prices only) opened on the first trading day of 2018-19 financial year still 9 per cent below its pre-GFC closing high (reached in November 2007) yet 97 per cent above its GFC closing low.

By contrast, the S&P/ASX 200 total return index (share price plus reinvested dividends) opened on the new first trading day of 2018-19 46 per cent higher than its pre-GFC high.Critically, this total-return index is 196 per cent above its GFC low.

The latest figures from super fund researcher SuperRatings reinforce why investors should take a disciplined, diversified and long-term approach without being swayed by day-to-day movements in asset prices.

SuperRatings estimates that $100,000 held in a median balanced super fund 10 years ago would have increased to $190,207 by the beginning of 2018-19. Critically, the total doesn’t include contributions.

These super fund returns reflect, of course, solid capital growth, reinvested income and the power of compounding returns. If regular compulsory and voluntary member contributions were taken into account, the total dollar figure would now be significantly higher than the $190,000 given this example.

While many investors of all ages fall into the trap of focussing excessively on short-term movements in asset prices, many retirees concentrate mainly on the yield or income side of their portfolios. This can lead to disregarding carefully diversified portfolios in an effort to boost income at a time of historically-low interest rates.

A way to help overcome an excessive focus on yield is for retirees in particular to consider adopting a total-return approach that focuses on both the income and capital growth generated by a portfolio.

Such a total-return approach should help retirees maintain a portfolio’s diversification, allow more control over the size and timing of portfolio withdrawals, and increase a portfolio’s longevity.

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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.

Robin Bowerman