Successful investing can be really hard in times like the present when most investment markets are down and very volatile on the back of uncertainty around inflation, rising interest rates and the war in Ukraine. While all volatility feels uncomfortable in the near term, the important question for all long-term investors is how to respond to it
Corrections are a normal part of investment market behaviour. This article puts volatility in context relative to historic trends, and then outline a few things to keep in mind when the market gets choppy.
“A SMOOTH SEA NEVER MADE A SKILLED SAILOR”
A market without volatility would be unnatural, like an ocean without waves. The free market, like the open ocean, is constantly churning. For some investors, market moving waves can be exciting, providing a buying opportunity for mispriced securities. But for most investors who focus on their long-term financial goals, the waves in the market can feel violent and threatening.
While all volatility feels uncomfortable in the near term, the important question for all long-term investors is how to respond to it.
GRAB AN OAR! LET’S PUT ALL THIS INTO SOME PERSPECTIVE:
Long-term investors who have sought and obtained proper financial advice should think of themselves as a cruise liner. Their diversified portfolio was built to feel steady in rough seas. Here are a few things to consider:
Volatility in the market is normal and feeling uneasy about a lower portfolio value is normal too. Illustrating how often we experience moderate pullbacks is simple enough— the chart below shows the annual return of the ASX 200 (the black bars) and the largest fall within each year (the red dots). It shows that its fairly normal to have a fall of 10% or more within a year. This has occurred in 21 of the past 28 years. And in 13 of those years, the ASX200 still finished higher for the year.
This chart also highlights that even in years with outstanding equity returns, there were rolling waves of volatility in the market. What we cannot show in a graph is the seasickness some investors at times feel while riding these waves to a lower portfolio value.
Source: S&P/ASX data reproduced with permission of S&P Index Services Australia
If you look at daily share market movements, they are down almost as much as they are up, with only just over 50% of days seeing positive gains. The same ups and downs would occur if you auctioned your home every day.
See the next chart for Australian and US shares.
So day by day, it’s pretty much a coin toss as to whether you will get good news or bad news. But if you only look monthly and allow for dividends, the historical experience tells us you will only get bad news around a third of the time. Looking only on a calendar year basis, data back to the year 1900 indicates the probability of a loss slides to just 20% in Australian shares and 26% for US shares. And if you go all the way out to once a decade, since 1900 positive returns have been seen 100% of the time for Australian shares and 82% for US shares.
Focusing on the long-term trends of the market rather than the short-term gyrations should give investors the confidence to ride the waves of volatility. When examining historic share market data, we see a consistent trend of rebounds following equity market pullbacks. That means that investors who jump ship or change strategy after a big wave may break the cardinal rule of investing by “selling low.”
Frequent pullbacks in the market although common, can be unsettling and may encourage market timing. In times like these investors should stick to their predetermined strategy and not jump ship. The less you look at your investments, the less you will be disappointed. The less you are disappointed the less you are at risk of selling at the wrong time and experiencing a permanent loss of capital
While volatility can cause major deviations in the near term for equity markets, investors should focus on their destination.
Investors with long-term goals who are, with the assistance of an experienced adviser, able to shift their focus to the long-term return potential of growth investments have the luxury of realizing infrequent negative equity market returns.
The final chart below shows that over the past 10 years, despite significant market corrections along the way including the one we are experiencing right now, an investment in a well-diversified Balanced portfolio has provided significantly more growth in wealth than an investment in cash
In fact, despite periods of volatility and various market corrections over the past decade (including the period we are in right now), $1 invested 10 years ago in a typical Calibre Balanced portfolio has grown to $2.34 representing an annualized return of 8.88% p.a. The same $1 invested in Cash would have grown to $1.19 over the 10 years, representing an annualized return of only 1.79% p.a.
10 year Cumulative return of a Calibre Balanced Portfolio versus Cash (to end of April 2022)
Source: Dimensional Returns Programme
Most clients need some exposure to more volatile growth assets to reach their long-term lifetime financial goals and staying invested throughout that time horizon can at times be their biggest challenge. Though it is impossible to predict the future, further market volatility in the coming years is a safe bet. Just as the last 10 years have favored the well diversified investor, we expect the next 10 will do the same.
The reward for taking a long-term time horizon is capturing the compounding effect that is forgone by others who quit before you.
If you have any questions/thoughts in relation to this article or would like more information, please contact Gordon Thoms or David Conte at Calibre Private Wealth Advisers on ph. (03) 9824 2777 or email us here.
The information contained in this article is of a general nature only and may not take into account your particular objectives, financial situation or needs. Accordingly, the information should not be used, relied upon or treated as a substitute for personal financial advice. While all care has been taken in the preparation of this article, no warranty is given in respect of the information provided and accordingly, neither Calibre Private Wealth Advisers, its employees or agents shall be liable for any loss (howsoever arising) with respect to decisions or actions taken as a result of you acting upon such information.
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