Something that drives me crazy about those Industry Super ads is the difference in nominal environments based on inflation and the way investment returns are disclosed. So hypothetically, if you have a environment like the 1970s where there was around 8% inflation,a 10% stock market return while it sounds good, means you only made 2% real return. 8% of the headline return is gone to inflation. So you’ve been left with a 2% real return.
In an environment like now which is, let’s call it 2% inflation, if you made a 4% return most people would say that’s not that good, its exactly the same thing as the 10% return mentioned above. Understand?
An example that is just as mind numbing is the traditional 8% expected return for a lot of Super Funds and Managed Funds. The reported numbers in the Industry Super Fund advertisements don’t change the reported numbers by the inflation environment. In the name of good logic this makes no sense! We could also start on about Defined Benefit Super schemes of public servants but that only makes everyone too upset about future public debt levels of Australia left for our kids.
Performance has always been published as nominal. It’s just 8% nominal, right? Some forecasts have come down a little bit in recent years as analysts finally realise we are in a low return environment. Anyway, everyone thinks of nominal returns because it’s harder to compare apples and oranges over various time periods. The golden age of hedge funds, certainly in the 70s, 80s, and 90s, had a much higher nominal inflation or environment. So when you look at great historical returns of managers including Bridgewater think of the above real return calculations. Additionally this has a lot of ripple effects.
The Ripple Effect On Financial Planner and Advisor Fees
A 1% or 2% fee on a 10% return doesn’t sound as bad as a 1% or 2% fee on a 2% to 4% return, ….get it? Clear as mud… the investment advisor fees seemingly increase as a percentage of asset return, but have they?
So looking back historically, a globally-diversified portfolio of equities has returned about 5% after inflation. Therefore an asset allocation portfolio has historically returned 4% to 6% real.
So the trick is to start thinking in real returns, especially when you see a smiley advertisement from a large wealth manager.
Remember it’s whats left out that usually matters.