Someone who managed to avoid the sharemarket’s 10 worst days over the past 26 years would have achieved an average annual return of 12.7 per cent. If they had avoided the 20 worst days, they would have earned annual returns of 14.8 per cent.
The problem, says Oliver, is that timing the market is not possible.
A person who missed the 10 best days on the sharemarket over the past 26 years would have achieved average returns of just 7.5 per cent a year. Had they missed the 20 best days, their average annual returns would have been 5.8 per cent.
Oliver cites another comparison over the long term – $100 invested in a balanced portfolio of equities and bonds since 1928 vs the same amount invested by someone else who moved 100 per cent to cash after each negative year in the balanced portfolio and then moved back after a year of positive returns (“because most investors only move with a lag after a period of negative returns”). Annual returns for the former would be 10.1 per cent vs 8.7 per cent for the latter.
In for the long haul
Financial Framework principal Dan Hewitt says he would ask a client who wanted to move out of equities as a result of recent market volatility what had caused them to change their investment approach.
“If it is market volatility, we must work through the noise and emotion and stay focused on the longer term,” he explains. “Markets go up and markets go down, but history has shown that equities is one of the best asset classes for investment returns over the long term.
Hewitt says periods of soft markets are often the best time not only to stay invested but to “top up”.
“I often use a supermarket analogy with clients when markets move substantially either way. Just like stocking up on Rexona deodorant when it is 30 per cent off, it can make sense to see these occasions as a buying opportunity if appropriate,” adds Hewitt.
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BFG Financial Services’ Suzanne Haddan recommends people use “dollar cost averaging” as a strategy for dealing with equity market volatility.
“This involves making regular investments over a period of time rather than one lump sum,” she says. Anyone making regular contributions to super is automatically doing this – the super fund can purchase more when the price is low and less when the price is higher.
“Time in the market rather than timing the market is what investors should aim for,” Haddan adds.
Research from Griffith University shows that 70 per cent of super investment switches made at the height of the pandemic in March and April 2020 led to poor financial outcomes.
Most of the loss-making switches during this time were people who moved out of growth assets such as equities in response to a falling sharemarket.
As you can see from the table, it took only 13 months after the 2020 market fall for prices to recover. Since 1950, the average bear market, which occurs when share prices fall by more than 20 per cent, took 13 months to hit its low point and a further 40 months to attain a new high.
Back to basics
The question of how much exposure investors should have to the sharemarket depends on their age.
“One of the biggest impacts on the rate of return achieved for a portfolio is asset allocation and hence the risk taken by a client. The higher the risk, the higher the expected return,” says Haddan.
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Superannuation is a long-term investment, she adds, and the benefits of a high allocation to growth assets can “significantly improve” retirement balances.
It made sense for young people to have higher-risk portfolios, she adds. “The old adage ‘time heals most evils in investment markets’ is particularly valid for younger people.
“That said, it is important to know when not to take higher risk – even when you are young. For example, if you’re planning to buy a home in the next few years, the risk of investing in shares is generally not a good idea.”
Financial Framework’s Hewitt says younger people typically have smaller sums of money and need their super to work harder. Short-term volatility is less concerning for them since they won’t be drawing down their super for decades.
“This is particularly the case in relation to their super when it can effectively be a 40-plus-year investment time horizon,” he says.
Keeping cash
Haddan says it is prudent for people in retirement to keep, say, three years’ worth of living expenses in the bank to avoid selling assets during a market downturn.
“The aim of the game is to avoid selling share and property investments at a bad time,” she adds.
“For most this can be achieved by holding sufficient cash and term deposits to cover at least three years of living expenses, and being willing to forgo discretionary expenditure – for example a new car – in difficult times in the share or property markets.
“Not many people believe cash and term deposits create the family wealth – they do, however, provide security, liquidity and financial peace of mind in retirement.”
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Fundamentals ‘pretty sound’
As for what the year ahead holds for super funds, Sunsuper chief investment officer Ian Patrick tells Smart Investor: “I’m not certain we are going to get the strong positive double-digit returns we had through 2021, but equities should deliver a positive return – maybe high single digits or just into double digits if we are lucky.”
Patrick says equity market fundamentals are “pretty sound”.
“There is relatively little pressure on corporate and consumer balance sheets that would [cause] a retrenchment in consumer spending and therefore an overall reduction in income, which would pressure equities.”
He says a combination of pent-up demand and high levels of household savings should prompt a “mini-boom” when supply chains recover from the omicron outbreak.
AMP Capital’s Oliver says it is “entirely reasonable” to expect sharemarket returns to be lower this year.
While share prices have recovered modestly from January falls, he says it is too soon to call an end to the correction. “The rally seems to have hit a bit of resistance. It’s still too early to say we’ve seen the bottom,” he says.
Returns aside, BFG Financial Services’ Haddan says successful investing should be “boring”.
“This relaxing state can be achieved by having a properly constructed financial plan that addresses your goals and objectives. You then broadly stick to the plan unless your circ*mstances change – rather than when investment markets change.”
Financial Framework’s Hewitt says: “Making a plan gives the money you are investing a purpose and a time horizon.
“By doing this, you are not fixating on the ‘returns’ but rather can focus on the goal and are better placed to work through times of market volatility.”
