What do Toilet Paper and the Stock Market have in common?
When you are uncertain about something, you make rash decisions.
This is what the Corona-virus is doing to our psyche – it is affecting our confidence.
Schools and offices are closing, cruise liners and hotels are having cancellations by the thousands, airline tickets are cheap, people are looking at options to work from home, and PM Morrison is asking businesses to pay their supplier invoices before they are due.
The value of stock markets around the world have fallen sharply. What does all this mean? What should you be doing?
It means that we are dealing with aspects in our world that we have not seen before and therefore our reaction is fearful.
Most of the time in our life, we do experience turbulent times with family, with work and with our investments, but in the majority of these times, we can control the outcome with a sensible approach.
When things seem to be out of our control and you look around and no one seems in control, and we’re expecting Governments, or the like, to solve the crisis we’re hearing about, that’s when rational thought goes out the door.
Our note to you today is not about what you should do regarding the corona-virus but more to address concerns you might have over your superannuation and investments. The things we as Advisers can guide you on.
The natural instinct is to flee the market because, as has been chronicled by psychologists, with loss aversion theory, people feel the pain of losing money much more than they enjoyed the gains.
1. Market declines are part of investing
Stocks have risen steadily for most of the last decade, but history tells us that stock market declines are an inevitable part of investing. The good news is that corrections (defined as a 10% or more decline), Bear markets (an extended 20% or more decline) and other challenging patches haven’t lasted forever.
The Standard & Poor’s 500 Composite Index has typically dipped at least 10% about once a year, and 20% or more about every six years, according to data from 1950 to 2019. While past results are not predictive of future results, each downturn has been followed by a recovery and a new market high.
2. Time in the market matters, not market timing
Market corrections are not uncommon and should not be unnerving. However, when investors see the value of their investments dwindling, their aversion to losses can compel them to sell – and once they have sold, they (generally) stay out of the market.
Unfortunately this can cost investors dearly, as those who sit on the sidelines risk losing out on periods of meaningful price appreciation that follow market downturns.
Even missing out on just a few trading days can take a toll.
A hypothetical investment of $1,000 into the MSCI ACWI (a global equity index representing the performance of all large and mid-cap stocks across 23 developed and 26 emerging markets) in 2010 would have grown in capital value (excluding dividends) to $2,060 by the end of 2019. However, if an investor missed the 30 best trading days of that period, they would have ended up with 99% less, as can be seen by the table below.
3. Emotional investing can be hazardous
Kahneman won his Nobel Prize in 2002 for his work in behavioural economics, a field that investigates how individuals make financial decisions. A key finding of behavioural economists is that people often act irrationally when making such choices.
Emotional reactions to market events are perfectly normal. Investors should expect to feel nervous when markets decline, but it’s the actions taken during such periods that can mean the difference between investment success and shortfall.
One way to encourage rational investment decision-making is to understand the fundamentals of behavioural economics. Recognising behaviours like anchoring, confirmation bias and availability bias may help investors identify potential mistakes before they make them.
4. Make a plan and stick to it
Creating and adhering to a thoughtfully constructed investment plan is another way to avoid making short-sighted investment decisions — particularly when markets move lower. The plan should take into account a number of factors, including risk tolerance and short and long-term goals.
One way to avoid futile attempts to time the market is with dollar cost averaging, where a fixed amount of money is invested at regular intervals, regardless of market ups and downs. This approach creates a strategy in which more shares are purchased at lower prices and fewer shares are purchased at higher prices. Over time investors pay less, on average, per share. Regular investing does not ensure a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.
Retirement Super funds, to where investors make automatic contributions with their Employer Super are a prime example of dollar cost averaging.
5. Diversification matters
A diversified portfolio doesn’t guarantee profits or provide assurances that investments won’t decrease in value, but it does help lower risk. By spreading investments across a variety of asset classes, investors can buffer the effects of volatility on their portfolios. Overall returns won’t reach the highest highs of any single investment — but they won’t hit the lowest lows either.
For investors who want to avoid some of the stress of downturns, diversification can help reduce volatility. The chart below shows the dispersion of returns for varying assets over time.
6. The market tends to reward long-term investors
Is it reasonable to expect 30% returns every year? Of course not. And if stocks have moved lower in recent weeks, you shouldn’t expect that to be the start of a long-term trend, either. Behavioural economics tells us recent events carry an outsized influence on our perceptions and decisions.
It’s always important to maintain a long-term perspective, but especially when markets are declining. Although stocks rise and fall in the short term, they’ve tended to reward investors over longer periods of time. Even including downturns, the S&P 500’s average annual return over all 10-year periods from 1937 to 2019 was 10.47%.
It’s natural for emotions to bubble up during periods of volatility. Those investors who can tune out the news and focus on their long-term goals are better positioned to plot out a wise investment strategy.
Note: These Principles taken from 6 Principles for Times of Turmoil: The Capital Group
In conclusion, it’s important to position your portfolio to navigate through cycles
Rothgard believes in a smarter way of investing that combines individuality and working with you into a tailored approach to help you meet your goals.
Please contact us to discuss your concerns or any other matter. We are with you through this challenging time.