Three tips for smarter investing in 2022
Share markets have rewarded many investors this year, however as the old saying goes, past performance is not indicative of future performance.
With this in mind, it's a timely opportunity for you to check in on your investment objectives and financial goals for 2022 and beyond and rebalance your portfolio accordingly.
1. Start by asking yourself: What is my investment objective?
One part of your answer should relate to the dollar value you're aiming for. The other should relate to timing. If you have $10,000 today, for example, how much would you like to have that grow to by the end of 2022, or 2025, or whatever end date you have in mind.
The dollar value you are targeting and the timeframe needed to achieve it are linked. If the dollar value you are targeting is high, you will need more time to achieve it. If your time is short, then your dollar value goal can't be too high.
Your investment objective will determine how much or, how little, risk you need to take with your investments.
2. Identify how you'll achieve your objective.
Next, you need to decide what your strategic asset allocation (SAA) should be.
This is the ratio of money that you invest in each asset class such as Australian equities, global equities, property, fixed interest and cash.
The combination and allocation to these various buckets dial up or down the risk of your portfolio and accordingly the potential returns. Equities are generally riskier with higher returns, whereas cash is less risky but has a much lower potential return.
An example of how you can structure your portfolio after considering your SAA is below:
As you can see above, changing your allocation can change the overall return of your portfolio.
However, it will also change the risk profile of your portfolio. The income assets typically fall less than growth assets when markets experience a crisis such as COVID-19 and this smooths out the performance of your portfolio over time.
3. Factor in changing market forces
The returns outlined in the table above are based on long-terms averages but as we stand at the beginning of 2022, it's also important to think about the coming year and to ask the question about what is likely to impact the markets.
So, what are the possible influences on the market in the coming year and beyond?
The big one will be inflation.
Throughout the pandemic, central banks around the world replicated the strategy they put in place through the global financial crisis, known as quantitative easing (QE) - which is effectively printing money.
They did this by making money cheap and easy to access. This facilitated borrowing and investment in businesses, which lifted the valuations of these businesses.
Central banks are continuing with QE, which is why equity markets have performed so well over the past two years, despite the initial shock of the pandemic.
But easy money supply and rising asset prices lead to inflation. And while some inflation is good the Reserve Bank of Australia (RBA) has a target range for inflation of 2-3%. As long as inflation stays within this range, the RBA's view is that the economy will be healthy.
If inflation starts to blow out, central banks will begin to reduce QE in an effort to keep inflation under control which generally results in an increase in interest rates.
When interest rates rise, asset prices will start to even out. We're already seeing this in property markets which were running hot through the pandemic due to lower borrowing costs.
If inflation rises quickly, there will be a pullback in share markets, but this won't be permanent. In fact, it might provide an opportunity to buy in at a cheaper price.
If central banks are successful and inflation goes up gradually, the market won't pull back but the growth rate will slow. In this case, there will be fewer bargains than if prices fall, but there will also be fewer risks so you can invest with greater confidence.
Other external shocks are harder to foresee.
One possibility is that there will be further market fallout from a fourth wave of COVID-19. In Europe, at the time of writing, several countries including Germany, The Netherlands and Austria have reimposed restrictions.
Markets may react in the short term but as vaccination rates increase globally, the opportunity for pandemic-related shocks will reduce.
Another risk arises from geopolitical tension between China and the rest of the world. Recent conversations between China and the US have been encouraging but with an election looming in China in October 2022, it is difficult to predict what President Xi Jinping may or may not do to shore up his election.
Reassurance in being prepared
Sure, there is a little uncertainty about how the economy will go next year and it is impossible to predict external shocks, but we can be prepared for the unexpected and thinking strategically about your investment objectives will make a difference.
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