Two financial advisers and a portfolio expert outline what to expect in the next 12 months and some basics on building long-term wealth.

Attitude toward risk

The widely published work of psychologists Daniel Kahneman and Amos Tversky found that a monetary loss will have a greater psychological impact than an equivalent monetary gain. 

Thinking critically about your level of comfort regarding fluctuations of individual assets or your entire portfolio will go a long way towards identifying the types of investments appropriate for you. 

Do you want greater stability in asset value with less potential for capital growth, or are you willing to accept higher volatility for exposure to potentially greater returns? 

Investment timeframe

Your investment horizon may be three years or 30 years, but to reasonably expect to generate the anticipated returns of a particular investment, your holding period must align with the corresponding investment period of the underlying asset.  

Objectives 

Financial and personal objectives often go hand in hand, and must be clearly articulated in your investment strategy so that the strategy itself is aligned with achieving what is most important to you. 

Do you want to ensure you maintain your current lifestyle into retirement? Do you want to become financially independent, retire early and travel the world? Do you want to build a legacy for the next generation of your family? 

Investment strategy 

Whatever your overall motivations, your objectives alongside your attitude towards risk and your timeframe for investing will dictate your investment strategy, and are critical factors in determining your asset allocation. 

Asset allocation establishes the right balance of growth and defensive assets for your individual circumstances. It enables diversification, which is important because asset classes have different levels of inherent risk, and different drivers of returns. 

By employing an asset-allocation approach, you are positioning your portfolio to generate more consistent returns over time. 

Implementation

The next stage of the investment process is to implement your strategy by constructing a portfolio. The investment universe is broad and diverse: investors can invest directly through share ownership, or indirectly via a managed fund or unlisted vehicle, which can in turn be managed actively or passively (an index tracker is an example of a passive investment). 

Regardless of how you invest, it is important that you understand each of your investments and the contribution it is making to achieve your strategy. 

An investment adviser will guide and educate you through this process, eliminating the noise surrounding investment markets, identifying opportunities, and minimising risks on an ongoing basis. 

A certainty in investment markets is variability, and within that context only some aspects of investing can be controlled. A sound investment strategy will give you peace of mind that you are exposed only to risks you are comfortable with, that you properly understand each investment and the basis for the underlying strategy, and that your portfolio is constantly working towards achieving your ultimate goals. 

(Editor's note: Do not read the following ideas as recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article).

We could also see some negative impact in late July-early August during the “confession season” when companies often disclose their profit downgrades in advance of the official result.  

Companies with worse-than-expected results due to the lockdowns and subsequent recovery will be treated harshly by investors.  

However, this is also when the share price of companies that announce solid results, or that they have not been as badly impacted, could rally.  

As with any reporting season, it will be a time when nimble investors can make money if their predictions come true.

While volatility brings increased risks – and potential danger – to those not planning for it, it is possible to benefit from volatile markets. Taking advantage of the swings in prices of individual investments or markets by trading can add “alpha” to portfolios (a return greater than the market return).

One of the most tested and important ways to benefit from and protect against volatility is to have a well-diversified portfolio with a spread across asset classes, sectors and securities.  

Interest rates are highly likely to remain at historic lows for FY21. The Reserve Bank has indicated the current official cash rate of 0.25 per cent is the lowest it will go. 

We don’t believe we will see a zero per cent cash rate in Australia, but a low cash rate will likely continue, supported by Quantitative Easing (QE), with the RBA now buying Government Bonds and providing additional liquidity support to the banks.

The low cash rates will continue to provide impetus for investors to seek other investment options and those wanting an income will continue to be “forced” up the risk spectrum to generate an acceptable return.  

Even after dividend and distribution cuts, the yields offered by equities, property and fixed interest are still substantially higher than returns from cash.  

Compared to the mid-to-high single-digit declines in GDP forecast for these countries in 2020, the subsequent counter-cyclical impacts of these measures are expected to be highly effective in terms of placing the global economy back on a growth trajectory. 

Morgan Stanley expects Australia’s economic performance for 2020 to be the best among G10 nations as the combination of a relatively less severe Covid-19 outbreak, quicker re-opening and robust fiscal position should lead to a gradual recovery from a more modest downturn. 

However, there are three key risks to our expectations that investors should monitor: 

1. Premature withdrawal of policy support. 
2. A second wave of Covid-19 that forces a return to lockdown conditions similar to what we are exiting. 
3. Escalation in US-China tensions in coming months. 

That said, we believe the recovery is now underway and investors need to position for the start of the next economic cycle. 

Just as a well-diversified portfolio was prudent in the downturn, it remains so in the recovery phase. It is pleasing that Morgan Stanley’s Core Balanced Combined Portfolio, which incorporates our views in selecting between active and passive strategies, has risen 0.6 per cent for the 12 months to 31 May 2020. 

In the context of the S&P/ASX 200 index, which was down 36 per cent from its peak in February to its low in March, a well-diversified strategy has again demonstrated the ability to navigate volatility better and produce a "sleep well at night" outcome for investors. 

Our model portfolios are positioned for the recovery. Within our equities allocation, we favour the quality and value factors that should benefit from a cyclical upswing. 

In terms of quality, we seek companies with strong balance sheets, high financial returns, and stable profit growth. 

For value, we look for companies with low valuations owing to depressed profits but whose financial situations are poised to recover. 

Within fixed-income allocations, we prefer corporate debt from both high- and low-quality companies. 

We are willing to accept the potential for higher default and credit downgrade risk in return for potentially higher income given the substantial monetary policy response, in particular by the US Federal Reserve. 

The Fed has committed to purchasing a wide range of corporate debt, which significantly reduces the risk in US corporate-debt securities. 

Within our listed property allocation, we encourage investors to use an active fund manager as we see the retail sub-category structurally challenged by digitisation and online shopping – a trend that has been accelerating during the Covid-19 pandemic. 

Morgan Stanley is bearish on the US dollar, which is likely to lead to a stronger Australian dollar, and we have therefore increased our hedging (currency protection) within our international equity allocations. 

In terms of defensive positioning, we expect a reduction in the diversification benefits from holding government bonds in a persistently low interest rate environment. 

We encourage investors to consider holding gold as another form of diversification in their portfolio. 

As a final point, responsible investing continues to gain momentum as investors take a more holistic approach to their portfolios. The growing choice of more true-to-label offerings and awakening to the interconnectedness between capital and social outcomes is a trend that continues to rise.