Staying the course through adverse markets

First, some context. All investment markets are down at the moment, be they property, bonds, or shares. There’s been nowhere to hide. The explanation for these declines is consistent, and that is rising interest rates. These higher interest rates in and of themselves have some direct relationship to the price declines that we have seen, especially in the bond market, but at least as significant, is worry that these rising interest rates will cause a recession in 2023.

Markets are forward looking. Prices today are reflecting expectations in the future, so the fact that in the here and now business profits are great and there’s record low unemployment doesn’t matter, that was reflected in last year’s share prices. To the same extent it may well be that next year we have a recession but you see investment markets rising, because they are looking to the inevitable recovery that we see on the other side.

So markets are behaving rationally to uncertainty. Right now we don’t know how high interest rates will need to go, and we don’t know if it will be the case that we get a recession next year. Of course the reality is we are always in a state of uncertainty, but sometimes there’s more of an optimistic outlook whereas at other times, such as now, pessimism rules the day.

For those reasonably new to investing it’s worth also flagging that whilst most of this calendar year has been a somewhat depressing grind, the declines we’ve seen have been pretty modest by historic standards. Certainly nothing comparable to the GFC back in 2008. This is especially the case here in Australia where our heavy exposure to the resource sector has given us a significant cushion. The big mining companies have made record profits and as a result distributed huge dividends out to investors which cushions the blow of any declines in market price. This means that some of the headlines we are seeing out of the US are misleading for Australian investors, and risk causing us to be more worried than is warranted.

Okay, so you’re across what’s driving markets, now what can we do to help ease your worry?

The first important concept to appreciate is that the value of your portfolio, be it superannuation or outside superannuation, is reflecting what you would receive if you sold all those assets today. The fact that that value might be less than it was six or 12 months ago doesn’t mean you have any less assets. In fact, if you’ve been contributing, as would certainly be the case with super and may be the case with your investments, then you would have even more assets than you had in the past. The value you see on your app or on your computer screen is only relevant if you are about to sell.

But perhaps you’re actually a buyer. Someone who is adding to their super or investments. As a buyer, low prices are good. When I do progress meetings with clients, I often take a look at the return of their investment since the account began. One client whose long-term returns have been particularly strong is someone who commenced a major investment towards the end of 2008, right in the depths of the GFC. It took some bravery, but by commencing your investment when markets are down he’s really locked in a very successful long term outcome. Yes, there was a lot of luck involved there. We can only invest when we have the money to do so, and none of us know what the future holds. But that example is a good illustration of why it is so important that we hold our nerve and stick to our strategy, even when markets are down.

Your investment strategy will be built to achieve certain objectives, most of which will be at a point in the future. During times like we’re currently experiencing, if you are having doubts about your strategy, revisit those objectives and consider whether they are still applicable. Perhaps you had a goal to be able to cut down your paid employment to three days a week from age 50. Is that goal still what you are after? If it is, then stick to your strategy, a strategy built with the knowledge that investment returns bounce around year to year, and periods like we have now are expected and normal. But if your objectives have changed, then it might be appropriate to consider whether changes are required to your strategy. If you have a relationship with a financial planner, consider scheduling a catch-up call to talk this through.

One simple way to be less worried about the value of your investments is to check them less frequently. Certainly, if you’re looking at your balances more than once a month, give yourself a good talking to. For most people, once a year would be sufficient. If you’ve got a well considered strategy in place that is working towards achieving your goals, then checking the current value if all your investments were sold, produces no benefit for you.

In times like these I sometimes get people ask whether they should switch to cash. As explained earlier, the driver for current market conditions is rising interest rates, so the train of thought will either be that at least in cash the balance won’t go down, or that a 3.5% return on a term deposit looks reasonably attractive compared to returns in the other asset classes over the past year.

All of us need some cash reserves for short term needs and emergencies. And once we’re retired you typically have somewhat greater cash reserves to provide stability and a buffer to ensure that your retirement income needs can be satisfied no matter what the market conditions. But those cash allocations aside, it makes no sense to invest the money you intend for long term growth into cash. Right now inflation is running at over 6% per annum yet a term deposit is paying barely half that. If you’re simply in a cash fund in your super account or with the bank, then you would be earning even less. This means the buying power of your money is being eroded. Even though it might seem like you are protecting your capital, in reality you’re getting progressively poorer with no potential to recover those losses. Sure, it might be the case that right now property or share prices are down compared to where they were a year ago, but at some point the value of those assets will bounce back, and we know from history that the long term average returns are considerably greater than the rate of inflation, ensuring your buying power is maintained, and indeed over time, enhanced.

A final point that I believe is significant. The reason central banks around the world are raising interest rates is to prevent inflation getting out of control, and return rates to some sort of normal level, so that when we strike the next economic speedbump, our central bankers have ammunition with which to see us through. Whilst the current rising rate environment is causing the value of investments to temporarily go down, in the medium to long term this is a price well worth paying. As we’ve seen through the pandemic, central banks have an incredible ability to insulate us from severe economic turmoil. They’re almost like the insurers of our investments. When the hose comes lose from your dishwasher and your house gets flooded, you’re up for a few $100 in excess, but after that the insurance company covers the rest. Central banks and investment markets are operating similarly. There’s a small amount of discomfort now, but it ensures that we can avoid significant pain in the future.