Total return is more than the price
An investment's return has two components: the change in price and the income it pays along the way. Ignoring the income understates the result badly. Dividends have historically accounted for a substantial share of total sharemarket returns, and reinvesting them rather than spending them is what turns a decent return into a large one.
Annualised return is the figure that allows comparison across different holding periods. A 60% gain over five years is not 12% a year; it is about 9.9%, because each year's return compounds on the last. Quoting the total gain rather than the annualised one is a standard way of making a mediocre result look impressive.
The other distinction worth keeping straight is nominal versus real. A 7% return with 3% inflation is about 4% in purchasing power, and purchasing power is what you eventually spend.
Why the average return is not the return you get
Sequence matters. Gain 50% then lose 50% and the arithmetic average is zero, but a $100 investment is worth $75. The geometric mean, the compound annual growth rate, is the honest figure, and it is always lower than the arithmetic average whenever returns vary.
Volatility therefore has a direct cost, not just a psychological one. Two portfolios with the same average annual return but different volatility end up at different values, and the more volatile one ends lower. This is the mathematical case for diversification: it reduces the spread of outcomes without necessarily reducing the average.
It also explains why recovering from a fall takes more than the fall itself. A 20% decline needs a 25% gain to get back to even; a 50% decline needs 100%. Avoiding large losses matters more to a long-term result than catching large gains.
Fees compound against you exactly as returns compound for you
A 1% annual fee does not cost 1% of your final balance. It costs about a quarter of it over thirty years, because the fee is charged every year on a growing balance and the money taken out stops compounding.
Concretely: $100,000 growing at 7% for thirty years becomes about $761,000. At 6%, the same investment with a 1% fee, it becomes about $574,000. The fee transferred nearly $187,000, on an investment where the manager took none of the risk.
This is the single strongest argument for low-cost index funds, and it does not require believing that active managers have no skill. It only requires noticing that the fee is certain and the outperformance is not.
Diversification, in the way that actually helps
Diversification means holding assets whose returns are not driven by the same thing. Twenty Australian bank stocks is not a diversified portfolio; it is one bet on one sector of one economy, held twenty times.
The dimensions that matter are asset class, shares, property, bonds, cash, geography, and within shares, sector and size. A portfolio spread across these does not eliminate losses, but it stops any single event from being decisive.
Australian investors face a specific version of this problem. Franking credits make domestic shares genuinely more valuable to a local taxpayer, which encourages holding far more Australian equity than the country's share of global markets would suggest. The tax benefit is real; so is the concentration risk, since Australia's market is dominated by banks and resources.
Time in the market, and why timing fails
Missing a small number of the best days materially reduces long-run returns, and the best days cluster near the worst ones. They arrive during the volatility that makes people sell. An investor who exits after a fall typically misses the recovery, converting a paper loss into a permanent one.
Dollar cost averaging, investing a fixed amount at regular intervals, sidesteps the decision entirely. It buys more units when prices are low and fewer when they are high, and more importantly it removes the need to have an opinion about what happens next.
The honest summary is that time in the market beats timing the market, not because timing is impossible in principle but because doing it consistently, after fees and taxes, is beyond nearly everyone who tries.
Questions people ask
- What is a realistic long-term return?
- Broad sharemarket indices have historically returned roughly 9-10% a year before inflation over multi-decade periods, or around 6-7% after it. Balanced portfolios holding bonds and cash return less with smaller falls. Any specific decade can look nothing like the long-run average, which is why projections should use conservative figures.
- What is the difference between average and annualised return?
- The average is the simple mean of each year's return; the annualised figure is the constant rate that would produce the same final value, accounting for compounding. Whenever returns vary, the annualised figure is lower. And it is the one that matches what actually happened to your money.
- How much do fees really matter?
- Enormously, because they compound. A 1% annual fee reduces a thirty-year outcome by roughly a quarter. On $100,000 growing at 7% over thirty years, a single percentage point of fees costs close to $187,000. Money that leaves the account regardless of whether the investment performed.
- Should I invest a lump sum or spread it out?
- Historically, investing a lump sum immediately beats spreading it out about two thirds of the time, because markets rise more often than they fall. Spreading it out reduces the regret if the market drops right after you invest. Both are defensible; the worst option is leaving it in cash indefinitely while waiting for certainty that never arrives.
- How many investments do I need to be diversified?
- Most of the benefit arrives within twenty to thirty holdings spread across sectors, and a single broad index fund achieves it in one line. What matters is not the count but whether the holdings are driven by different things. Twenty stocks in the same sector behave like one.
Sources
- ASIC Moneysmart: investing basics. Independent guidance on investing, risk and fees