Volatility in the sharemarket is at long time highs. A lot of people’s first instincts in such times is to lump sum buy and sell. Some see this as a time to get out, whereas others see it as a time to get in. They are scared that:
They will lose more money so sell out; Or
They will miss out on buying ‘cheap’ shares; Or
They will miss out on the recovery
Whatever your reason it is extremely hard to get the timing right when the market is experiencing such wild swings.
The NZX50 market returns for the past two weeks:
13 March: Down 4.9%
16 March: Down 3.6%
17 March: Down 0.5%
18 March: Up 0.2%
19 March: Down 3.6%
20 March: Up 1%
23 March: Down 7.6%
24 March: Up 7.2%
25 March: Up 1.7%
26 March: Up 3.9%
27 March: Down 0.8%
These are some massive one day changes. Both up and down, although more down. The same is occurring worldwide.
So to try and get the timing right where you can take advantage of these prominent movements is extremely difficult. It’s hard enough when markets are calmer, let alone so volatile. How do you know if shares are expensive, cheap or fairly priced?
I see people trying to gain shelter from this volatility by buying and selling at what they think are good times. This is a sure fire way to get burned. There are much better ways to protect yourself from volatility than buying and selling like this.
How to protect yourself from market volatility
1/. Have a well written investment plan
There will be times when the markets get choppy and you will be tempted to react. To stop yourself doing anything hasty, it is best to have a written down investment plan that you stick to no matter what. In this plan you will include:
What you want to achieve by investing. Your goals
How long you are planning to invest for
How much you want to invest per week, month, or year
What your ideal asset allocation is. For example, 70% growth, 30% conservative
How often you want to rebalance your asset allocation. If growth or conservative assets have a very good or poor year then your fictitious 70%/30% growth/conservative portfolio will drift away from these percentages. Annually is often considered a good period of time to rebalance back to original goal of 70/30.
Where you want to invest. For example, 20% NZ share fund, 60% worldwide fund, 5% emerging markets fund, 5% Australasian property fund, 10% bond fund
How you want to have your investments managed. Actively or passively.
How you will control your emotions and what you will do if asset prices fall. If you have a solid plan that considers your investment horizon, goals, and tolerance for risk, the answer here is do nothing
The best time to write an investment in plan is early in your investing experience and at a time when the markets are not so volatile. Writing a plan when your emotions are all over the place is a recipe for disaster.
2/. Invest in shares only for the long term. 10 years plus
There is a good chance that shares will decrease in value for periods of less than 2 years. Less of a chance over 7 years and a much smaller chance over periods of 10 years. If you don’t need the money until much later then you shouldn’t be worried about the current volatility. Especially if you are buying into the market every month. You are now buying cheaper shares that will offer good value for money over the long term. If you don’t need to sell then volatility shouldn’t concern you. In fact, if you are anything like me, it should excite you while you are in the accumulation phase.
Short term noise in the market will make you want to jump ship. Stocks go up, stocks go down. Understand that there is volatility in the short term, but over time the value of most companies will go up.
A few NZ specific stats (pre 2018) to show how volatile the market can be:
The average return since 1975 has been 15.4%
The average return since 2000 has been 8.1%
In 41 years of data there have been 13 down years and 28 up years. A ratio of 2 years out 3 in positive.
7 of the 13 down years have been down by over 10%.
Maximum down year was 48.2% in 1987
Maximum up year was 117% in 1983
Highest up year in the last 20 years has been 26% in 2003.
If you had money invested before and during the 1987 sharemarket crash (48%), it would have taken 19 years to get back to break even (with no buying or selling). This wasn't helped by another large crash of 40% just 3 years later.
If you had money invested before the 2008 recession (33%), it would have taken just 4 years to break even (with no buying or selling). 9 years later and you would have almost doubled your money.
The 1987 crash was preceded by a 260% increase in the previous 4 years so was an anomaly. 3 years later the 87 crash was also followed by a 40% crash in 1990. Yes, it wouldn’t have been great, but it is of some comfort to know that if still invested today you would have almost double your money. If you were investing cheap shares during the crashes you would be even better off today.
The early 90’s experienced some very good returns and I imagine a lot of people sold during the 87 and 90 crash, and would have been scared to re-enter the market. Fair enough too. But all emotion taken out, they missed out on some good returns.
The point is short term is dangerous, long term not so much.
3/. Have an appropriate asset allocation
What I mean by asset allocation for example is 70% in shares and 30% in bonds. Very simple illustration but it basically means how much risk you are willing to take on with growth assets such as shares and property and how much stability you are wanting with more conservative assets such as bonds and cash.
It’s important to revisit this allocation at least every year. As time goes on your ideal asset allocation will drift too heavily in favour of growth or conservative assets depending on how they have performed. This will leave you either taking on too much risk, or not taking on enough.
Only you know how much risk you are willing to take on. The experience of the last few weeks of Covid 19 will have taught many investors how much risk they are willing to take on. Because the markets had previously performed so well for so long, many people had never experienced large drops in the market so didn’t know how they would react. Well now they do!
4/. Be well diversified
Having a widely diversified portfolio will significantly reduce over exposure to any one market or asset type. Although all assets seem to be dropping in value now, that is not always the case. And some assets such as bonds, are dropping in value much slower than shares. They offer a nice hedge. It is people who are invested in a small number of shares such as Sky City, Air NZ, A2 milk, and Sky TV that are really panicking now.
5/. Have an emergency fund
My emergency fund currently sits at approximately 1 years worth of expenses. This is money that could have been used more productively in the past in shares, however it is worth it for me as it allows me to stay calm during these times. I’m at a real risk of losing my job. My company is bleeding money at the moment due to our high fixed costs. Without revenue coming in there will be job losses, especially if the lockdown extends past 4 weeks. But this emergency fund allows me to stay the course and not have to sell shares or bonds that are going down in value.
6/. Being adequately insured
Again, this will ensure you are well covered for any job losses or losses in income which in turn will allow you to keep your money in the markets and not worry about having to sell at a loss.
7/. Stop looking at your accounts
If you can avoid it, don’t look. You know you will be down, do you really need to know by how much? By looking all you are doing is increasing the likelihood of panic selling before you lose more.
8/. Realise volatility is normal
Markets go down every few years. They go down significantly every decade. You should not be surprised when it happens, yet every time it does we don’t seem to learn or are not prepared. It is happening now and it will happen again, many times in most of our investing lives. Understand that and prepare for it. The more you realise this, the less chance of reacting inappropriately.
9/. Stop listening to everyone’s market predictions
They may be right, but they’re probably wrong. The main job of the media is to sell news. A lot of information is exaggerated, either towards the good end of the scale, or the bad end. You don’t hear about stock market gaining 8% in a year. You will hear about a fall of 1%. This is because people are predisposed to pay more attention to losses than gains. Don’t be scared off your course.
10/. Stop trying to time the market
Despite what anyone says, it is impossible to make predictions about the price movements of stocks. Fight the prediction addiction. It is all very exciting making predictions when they come off, but it is also dangerous. Trying to time the market by guessing when a good time to buy or sell is, often results in poorer returns than if we just rode the market.
We may think it is the top of the market and sell, only to find out that the bull market still has another 3 years of rising stocks. That would be a long time to be sitting on the sidelines during the best possible time and not even be invested. Conversely, buying all in when we think the market has bottomed out, only to find it is only half way to the bottom. It is a fool’s game.
There’s no reason we can’t do as well as the pros. What we cannot do is to beat the pros at their own game. The pros can’t even win their own game! Why should we want to play it at all? If we follow their rules, we will lose – since we will end as much a slave to Mr market as the professionals are.
11/. Know what you are invested in
If you know this, then you have less chances of being surprised by different outcomes. If you don’t understand, then unpleasant surprises you cause you to negatively react. It always amazes me when people are surprised when their shares go down in price.
Final thoughts
The safest way to invest is for the long term, with a buy and hold strategy, regular investments, in a wide range of low cost funds, whilst sticking to our plan, avoiding the noise, and not letting our emotions get in the way. Having an adequate emergency fund and insurance cover will also help greatly with regards to sticking to your investment plan as it will provide a nice buffer.
The whole point of investing should not be beating the average, but to earn enough to meet our needs. Problems arise when we start looking for the "best” investment or the next “hot” thing. In other words, don’t take on more risk that you want or need.
Risk is natural. As long as we can identify risk ahead of time we can employ methods to minimise it. The key is to understand what we are investing in so that we are not blind-sided by events we are not prepared for.
And understand that downturns happen. Frequently. I repeat. THIS SHOULD NOT BE A SHOCK. The only shock is that this one took so long! We’ve had a very long time to prepare for this one, yet people are still panicking and doing silly things with their money.
Get all that right and you are more likely to accept the volatility and not doing anything that you never planned to do.
If you need an investment plan or recommendations , then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here