Written by Ivan Fletcher
Many investors become concerned when volatility occurs in financial markets – particularly about the impact on their superannuation and other investments. In times like these, it is important to understand the causes of market movements and how to minimise your risk.
Why do markets move so much?
Markets are influenced by many things – industrial, economic, geopolitical and social factors, natural disasters can all have an impact. For the last 2 to 3 years we have experienced a global pandemic which has had many phases through continued lockdowns prior to readily available vaccinations, including phases of continued government financial support and ultra-low interest rates to now where the economies are opening back up and the economic cycle recalibrating to normalised interest rates to stabilise inflation.
The Russia-Ukraine War situation has disrupted supply chains in certain industries which has put further pressure on inflation.
Impact of Uncertainty
Share markets do not like uncertainty and is one of the key drivers in a Bear Market such as we are experiencing now. We saw a 35% fall in share prices in just 6 weeks from Mid March 2020 when the world first faced the realities of the pandemic, but within 6 months had fully recovered on the back of the government stimulus and further reduced interest rates. The markets had restored faith that the actions of world leaders and central banks would assist us thru the worst.
We have seen the same thru multiple war situations. When war breaks out unexpectedly, share markets react negatively, uncertain on how big or deep the impacts might be. If you remember the IRAQ and AFGHANISTAN conflicts, the mere arrival of allied troops to those destinations brought comfort back to the share markets.
During times of market volatility, it’s important to remember one of the fundamental principles of investing – markets move in cycles. Investment returns in the share markets are not evenly spread over 12 months or 365 days nor from year to year. Share markets on average will experience a significant negative year on average every 4-5 years. Historically the length of a bear market has ranged from 3 months to 18 months. We are currently now 11 months into the current Bear market.
What is the effect of market volatility on super funds?
In times of market volatility, your super balance may decline, but it is important to remember that markets move in cycles. Volatility is a natural part of the economic cycle. Markets are influenced by a range of factors and are inherently unpredictable. It’s in times of volatility that we need to be reminded not to panic if the short-term returns are negative: remember that super is a long-term investment”. History demonstrates that over the long term, the general trend of share markets has been upward.
The last market highs for Australia (All Ords 7926.8) and USA markets (S&P 500 4796.56) were on 4th and 3rd January 2022 respectively and the most recent lows were on 20 June 2022 (Australian All Ords at 6609.5) and for the USA on 12 October 2022 (S&P 500 had a low of 3577.03). For many of you who have received half-yearly statements from Superannuation accounts (from 1 January to 30 June), they literally reflect the full effect of these market falls.
Whilst the markets have experienced some recovery in the last 2 months since the end of September there is no clear indications that the market has reached the bottom of this cycle. July and August produced some good upswing in markets before September brought it down again. The most recent upswing is still with the ranges of the downward ranges of the bear market.
SO – HOW DO YOU KEEP YOUR NERVE?
- Don’t lose sight of the bigger picture
Super is a long-term investment. Shares, which usually form a large part of most balanced super accounts, are also generally a long-term investment. They are designed to provide capital growth over a period of five years or more. Think in years, not days. The time frame for super may be 20 years or more, so short-term volatility shouldn’t diminish the long-term potential of your investments. Growth assets (such as shares) tend to fluctuate in the short-term, but have historically provided excellent returns for investors over the long-term.
When share markets fall in value, it may be tempting to sell up. However, trying to time the market by selling now and buying back later is a risky strategy that rarely results in investors coming out ahead. By taking a long-term view of investing, you can ride out any short-term fluctuations in the market and take advantage of growth opportunities over the long term.
Retirees – if you have your Pension funds invested with Hudson, these are the times when your Bucket Strategy works for you, allowing you to draw for up to 3 years from cash and fixed interest investments without having to consider selling a single share investment to fund your lifestyle, allowing time for markets to steady before you have to make this consideration.
Most of us have a Life Expectancy well beyond the next 5 or 10 years, and your investments still have plenty of recovery time.
Diversification is one of the most effective ways of managing volatility. It can help deliver smoother, more consistent results over time. Your investment may benefit by being spread across a variety of asset classes, including shares (domestic and global), fixed income, cash, direct and listed property, and infrastructure. This diversification should help soften the effects of any share market falls as some asset classes often tend to do well whilst others are struggling. Also, spreading your assets around means you are less reliant on any one asset class at any particular time.
For example : Prior to the pandemic Global shares (in particular USA markets) outperformed Australian shares for several years, however in the last 12 months it has seen a sharp turn the other way around.
- Understand your risk profile
All investments carry some risk. How much risk you’re willing to accept will be influenced by your financial situation and needs, family considerations, time horizon, and even your personality.
A common misconception is that your risk profile changes when markets go down – NOT THE CASE. It is more likely that you are facing your true risk profile for the first time. To use a sporting reference, it is not how humble or obnoxious we are when winning, but how we handle defeat or loss that provides a truer insight as to our personality. The same applies to our Risk Profile for investing.
If market volatility has caused you to reassess the way you feel about risk, it’s important that you discuss this with your adviser as these are the times that are more reflective of your risk appetite.
CONSEQUENCES OF WITHDRAWING – for the wrong reasons
Before making any knee-jerk withdrawal from an investment you should understand all the implications, risks and costs involved.
- Crystallising losses. If the value of your investment is falling, you are technically only making a loss on paper. A rise in prices will return your investment to profit without you doing anything. Selling your investment makes any losses real and irreversible.
- Incurring capital gains tax (CGT). Make sure you know what your CGT position will be before selling any asset.
- Losing the benefits of compounding. If you’re thinking about making a partial withdrawal from an investment, remember that it’s not just the withdrawal you lose, but all future earnings and interest on that amount.
Whilst it is could take up to 2 years before we see inflation back down to the central banks preferred range (2% to 3%), every positive sign along the way that it is retracting will likely give comfort to central banks to take the foot off the interest rate pedal and will be celebrated by the share markets. I expect there will continue to be surprises and bumps along the way, but as one tide turns (eg inflation and interest rates reducing) so does another (Share markets rising).
As is always the case, cheaper markets create opportunities for new investments. All too often we don’t realise this until the market has significantly recovered from a low that a great opportunity has been missed.