Many investors appear to have the low-return blues at present. It's not hard to see why: interest rates are low, shares remain volatile and the property market has been weak.
Investing capital in these markets is challenging. But there are some old-fashioned strategies that can help mitigate the impact of these worries.
For a start, investors should be thankful for what we have that others don't: higher interest rates, higher dividend yields and declining taxes.
There are about 820 million people living in countries with official interest rates of 1 per cent or less. While we have our challenges here, at least we can find deposit rates of 4 to 6 per cent and dividend yields on shares of 6 per cent or more.
So we should spare a thought for investors in the US, UK, Europe and Japan where deposit rates are barely above zero - call deposit rates of 0.2 per cent are the norm in the UK and dividend yields on shares average 2.5 per cent.
These countries haven't had the commodity booms we have enjoyed in Australasia and have much bigger problems in their banking sectors. As a result, many Northern Hemisphere government accounts are in a mess. Budget deficits are unsustainable and debt levels are growing. Higher taxes and budget cuts beckon.
The most important step investors can take now is to accept that returns are going to be lower than they have been in the past, at least for the immediate future.
While property prices have weakened during the past two years, affordability hasn't improved much, and rental yields are still relatively low.
Against this backdrop, a quick recovery to the double-digit returns we saw during the boom years seems unlikely. Returns will likely be driven by cash flow, rather than by significant capital gains.
In fixed income, the days of 10 per cent "risk-free" returns are well behind us, perhaps for a long time. The Reserve Bank lists the six-month deposit rate as 4.7 per cent.
In the bond market, a five-year government bond is yielding 4.2 per cent, highly rated five-year corporate bonds around 6 per cent, and unrated higher-risk corporate bonds with the same maturity average about 7.5 per cent.
All up, a diversified and laddered fixed-income portfolio may provide an overall return of 6 to 6.5 per cent.
In the share market, a globally diversified portfolio of blue chips can be put together that will produce a pre-tax dividend yield of 5 per cent. A number of leading New Zealand companies are offering higher yields than this and a New Zealand portfolio might generate a pre-tax dividend yield of 6.5 per cent.
With shares, the return comes from dividends and from dividend growth. Dividend growth is directly linked to earnings growth (assuming payout ratios are held constant) and it is this earnings growth that drives share prices higher. Let's assume that over the long term, earnings growth will be 3.5 per cent.
This may sound a little low but, given the short-term outlook for inflation and economic growth, we're comfortable on the conservative side of the fence.
Add this 3.5 per cent growth rate to the 5 per cent dividend yield (let's use this estimate instead of our aforementioned 6.5 per cent, to again err on the side of conservatism) and we get a potential total return of 8.5 per cent from shares.
Using these numbers, a portfolio split evenly between fixed-income and shares could be expected to return 7.25 per cent. Admittedly that's not a return that will see many of us singing from the rooftops, but it's a realistic starting point.
Another important strategy for handling tough markets is to focus on income. With shares, dividends are often overlooked as many people focus on trying to find capital growth. However, we believe capital growth is driven by earnings growth - in other words a company that grows its profit and dividend should have a rising share price as well.
On this basis, it would appear sensible to invest in companies that pay decent dividends and that have a good chance of growing that dividend as a result of an increasing profit, and capital growth should follow. Dividends also provide a degree of stability to a portfolio, as they are more stable and predictable than changes in share prices.
Simply including shares in an investment portfolio is a strategy that many investors avoid like the plague, but it is worth consideration in this low-return world. Shares provide income from dividends, as well as the potential for income growth, and protection against inflation.
Diversification is an unbeatable strategy in all markets. Combine fixed-income and shares together in a mix that suits your tolerance for risk.
There is clearly a trade-off involved. When you invest in fixed-income you give up higher potential returns, but you do get more certainty. Shares offer higher rewards, but with greater uncertainty, and increased volatility.
The past quarter has shown how important it is to not let market sentiment drive your investment decisions. In June, the economic outlook took a turn for the worse, here and overseas. Unemployment was worse than expected, house sales weakened and sentiment fell.
Economists started to cut their GDP growth forecasts. The Reserve Bank followed suit, taking the axe to its growth forecasts from June in its September review.
It would have seemed sensible to avoid shares from June onwards. You could reasonably have expected the share market to fall on the back of this bad news. However, it has done the opposite.
Our market has risen 10 per cent since the beginning of July. Markets are unpredictable and often do best when sentiment is at its darkest. You can actually take timing right out of the equation by staggering your investing over time, which is another good strategy for the uncertain times we face.
With more modest returns likely over coming years, it is worth turning to one of the most fundamental but powerful investment rules of all time - compounding.
Many people live off the income from their investments and compounding the dividends and interest is simply not viable. However, those who can reinvest the income from their portfolio should do so. The power of compounding will make a significant difference to returns over time.
There are no silver bullets when it comes to investing, and it is undeniably tough at present, but it arguably always seems difficult.
Having realistic return expectations, focusing on income, compounding income where possible, including shares in your portfolio while keeping a good balance between fixed-income and shares, investing gradually and ignoring sentiment are all strategies that should help provide a solution to some of our current investing dilemmas.
* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.
<i>Mark Lister</i>: Unlocking decent returns in tough times
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