Long-term may be much longer
Long-term return average can be highly misleading without a true appreciation of volatility, Milliman believes.
An analysis by Milliman principal, senior consultant, Wade Matterson, and head of fund advisory services, Michael Armitage, said that long-term may be much longer than investors were prepared for and the risks on the journey were far greater than imagined.
"While there is a strong correlation between risk and return, there are often long periods of time when investors aren't rewarded for taking on greater risk," the analysis said
Pointing to a study that found an approximate one-in-five chance that a 20-year historical equity return would be lower than the risk-free return, the pair said such episodes of long-term underperformance were cause for concern and that outside of superannuation, few investors held their investments for more than a decade.
"But ‘buy-and-hold' or ‘set-and-forget' strategies are clearly not an adequate safeguard against risk. Neither is chopping and changing investments in the face of volatile market conditions given widespread behavioural biases and the generally poor results generated by trying to time markets," the analysis said.
Matterson and Armitage said investors needed risk management that extended beyond the traditional safeguards of a long-term perspective and diversification.
"A more sophisticated approach to risk management should be holistic and flexible enough to accept the behavioural shortcomings of investors. In many cases, this will mean leaving some returns on the table in return for less volatility and greater certainty," they said.
"Advances in technology now allow advisers to genuinely assess the risk that investors won't achieve their goals by running real-time simulations incorporating thousands of potential market scenarios. They can then decide which actions they need to take to reach them."
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