Investment Markets and Investor Behaviour:
strategic investment criteria has been exposed

helmeted mouse at cheese laden mousetrap contemplating strategic investment criteria and the risk-v-reward payoff

The strategic investment criteria of any investor, will reflect their individual investment philosophy: readers who adopt a more intense trading pattern in their financial management will not find commentary in this article that would relate to that practice. A common theme for both traders and investors will be the desire to improve their position over time: for both, the Risk -v- Returns (Rewards) struggle is ever-present. Note: Continuum Financial Planners Pty Ltd advisors work with clients who do some trading – but do not advise on timing or product for that purpose.

The following matters tend to influence the investment activity of market participants, whether they be technically trained and competent, or lay investors alike –

Persisting theme: investor sentiment affect on markets
Over any given period of time – and regardless of the market circumstances at the time of an investment program being undertaken – there is a persisting theme observed in investors, that they watch the market and trouble over excessive movements in market valuation.

A reality that needs to be borne in mind by investors, is that market valuation is driven by investor sentiment (which is oftentimes reacts to media headlines). Just as this emotional response to market indices is persistent, persistence with an investment strategy has been a proven success. (See our article ‘Strategic Asset Allocation to achieve financial goals‘ for more on the benefits of this concept.)

Markets predict economic activity
The financial marketplace is not unlike any other marketplace: it reflects a number of competing interests – supply v demand; investor (buyer) expectations; funds available for investing – capital; political stability; geographical/ climatic circumstances; market breadth and depth – liquidity; competition; and the list goes on.

Taking all of these matters into account; and being satisfied as to the certainty of the level of knowledge about them, in a perfect marketplace, the prices for any item (share, commodity, consumables, or even cash or gold) anticipate what lies on the coming economic horizon.

Strength of equity returns -v- interest on deposits
Cash/ bond investors from time-to-time see that there is an increasing acceptance of investment risk in the marketplace – and are seeing their investment capital value being eroded accordingly, giving way to increased yields on those investments on the long term horizon.

Shareholders may at the same time, experience returns from dividends at a higher level – and more tax effective – than interest rate returns, basing the calculations on current market prices.

These movements indicate that the respective capital markets anticipate that there is economic recovery on the horizon; that capital will be required by corporations to expand in the recovery cycle; that this demand for capital will increase those interest rates; and that dividends will continue to be paid (in the Australian case, tax effectively).

Understanding investment asset risk/ asset allocation

There are three underlying investment asset classes: these are Cash; Equities; and Property. All other investments are in one form or another, derived from these groupings. Each of these asset classes has particular risk factors to be considered when adopting a strategic investment criteria in constructing an investment portfolio: and those factors are around certainty and suitability. The following table shows the key risk factors attributable to each of the classes shown:

Risk Factors Cash Equities Property
Interest Rate movements Returns decrease if official rates fall Returns tend to decrease in response to rate rises Returns tend to decrease in response to rate rises
Inflation Risk  (purchasing power) No protection from inflation Some protection through capital growth Some protection through capital growth
Liquidity Risk Very liquid Usually liquid (easily convertible to cash) Very illiquid (particularly direct property)
Capital Volatility None/Low High Med/High
Tenancy/Supply Risk No No Yes – inability to find ‘good’ tenants reduces returns
Tax Protection None Med/High – franking credits and tax-favoured treatment of capital growth Med – tax-favoured treatment of capital growth
Economic Downturn No Yes – ‘shocks’ in the economy are usually reflected by the market in advance of poor economic news Yes – lower returns lag poor economic news

Appropriate levels of probability of realising the various risks are statistically calculable; and need to be taken into account when an investor builds a portfolio. (In any individual portfolio, the entirety of the investment activity should be brought to account – not just particular portions of it unless for some strategic purpose which should be spelled out in the formulation of the strategic investment criteria for that specific part of the portfolio.)

Reaction to ‘market intelligence’
As intimated earlier in this article, investment decisions are predicated by market intelligence: and interpretation of that intelligence! Investors are, when all said and done, human beings – each with different ethical, educational and emotional make up. Depending on whether the reader of information is a ‘glass half-full’ type of person (or otherwise), the understanding of that information – in the same ethical, emotional and educational background – will result in a different interpretation.

Understanding this factor is important for investors as well as to advisers providing wealth management advice (at all levels – accountants, bankers, financial planners, lawyers and so on). Equally important, is ensuring that the decisions made in relation to an investment action are as completely informed as possible, appropriate to the individual needs, goals and objectives of the investor; and in accordance with their strategic investment criteria.

Financial planners are required to ‘know the client’ and to ‘know the product’: in this respect, advisers at Continuum Financial Planners Pty Ltd work to the mantra – ‘we listen, we understand; and we have solutions’ so that our investment strategies are delivered as personalised, professional wealth management advice.

Ignore predicted numbers
Decisions made on investment timing, based on predictions of where the ‘market index’ will stand at some future time will have little probability of achieving the desired outcome. In a similar way to understanding that past outcomes are not necessarily reliable guides to future performance; so predictions of future index levels are ignorant of factors not yet known. [Consider some of the risk features tabled above.]

Cash may be king – but Strategy rules
Throughout the period leading up to and for several months following the GFC (Global Financial Crisis), an effective investment strategy proved to be the most significant weapon in countering poor market performance periods for investors.

Investors who embarked on long-term strategies continue on their pathway to achieving the goals and objectives to which they were targeted. Those who substantially stick to their appropriately framed strategy are aware that in the long-term, the market will resume its trend to higher values: others whose timelines are not so accommodating, need to make tactical adjustments to reinforce the outcomes of the strategy – and as markets (and economies continue to emerge from the depths of that GFC) both groups see ‘the darkness diminishing’ and benefit from the improvement of investor confidence, looking to the ‘light at the end of the tunnel’.

Investors (and indeed intending investors) are encouraged to formulate/ review their strategy, their available timeframe, their portfolio, their available funds for investment and their investor risk aversion profile – and consider dollar-cost-averaging into an investment program that satisfies their identified needs, goals and objectives.

Is your strategic investment criteria clearly understood?

The experienced team at Continuum Financial Planners Pty Ltd are available to help you develop a strategic investment plan that meets the positive criteria from above. Please call our office (on 07-34213456) or use our website Contact Us facility, to arrange a meeting with one of us: your approach will be promptly and courteously attended .

This article was originally posted in June 2009: it has been updated/ refreshed from time to time, most recently in  July 2021.