If you’re constantly looking at the value of your investment or pension funds over the past couple of weeks, it can be hard to make sense of what’s going on, and what you should do.
One day they’re up 3% and your fund value has gone up by €5,000, and you have hope and feel great, and then your heart sinks the next day, because when you log back in, the value’s gone down by €10,000 after a 6% drop.
You’re in that state of limbo, of not knowing what to do, but you feel you should be doing something. And it’s easy to get nervous during times like this, but you can’t lose sight of what your investing for, and the key is holding your nerve, and staying patient. As Benjamin Franklin once said, he who can have patience can have what he will.
Investors who are confident that their fund is still aligned to their risk profile, don’t micro-manage their portfolio every day. The barely look at it. Because they know if they did, they could be duped into making a decision driven by emotion, which later turns out to a poor one, but unfortunately the damage is done, and its impact could have a ripple effect on their fund for years to come. So, they don’t overreact, they stay focused knowing whether their fund drops or increases in value, that over time, it will produce excellent returns for them. And that is average returns of somewhere between 6.6% and 7.2% per annum.
Whenever I’m in doubt about anything, I look at data and the past to see what happened when similar falls occurred to markets. And when I look at both, what stands out for me is that (a) stock markets go up over the long term and (b) the biggest gains tend to follow the biggest falls.
If we look at the S&P 500 as an example, it has produced positive returns in 40 of the past 50 years. So, it has had an 80% success rate since 1970.
And you might think that what’s happening right now to markets has never happened before, will think again, because it happens more often than you think. If you go back to a starting point at 1950, fall’s like the one we’re currently experiencing have occurred about once every 5 years, with an average decline of c. 30%, and the average recovery lasting 1 year.
For example, back in 1969, markets dropped by -34.70% and it took 366 days before the market recovered. In 1987, markets dropped by 33.50% but it took 101 days before they came back. And, of course there were other declines that took longer to recover i.e. when markets declined by 56.5% during 2007 and 2009, it took 515 days before they got back to pre-crash levels.
So, stock market falls are inevitable, but so are their rebounds. Some might take longer than others, but they will rebound to their previous highs.
Let me give you a quick example to explain this in more detail.
If you invested €20,000 in September 1987, a month before the crash happened back then, you would have seen the value of your investment a year later, reduced in value by 15.908%, with €16,818.40 sitting in your account.
By June 1989 (22 months later) you’re back at breakeven.
And 5 years later, the value of your fund would have increased by 31.308%, an average annual return of 5.599%, and now €26,262 is sitting in your account.
5 years on again, guess how much your €20,000 is now worth?
And I understand that comparing previous stock market crashes against what’s happening now is difficult, but as someone said recently, when it comes to your health and your wealth, you should wash your hands then sit on them, do nothing and don’t be pressing any panic buttons.
There’s a commonly held belief by some people, that returns are primarily determined by investment performance, but in reality, it’s determined by investor behaviour. And for a second week in a row, I’m going to reference the greatest investor of them all, Warren Buffett, who says the stock market is a device for transferring money from the impatient to the patient and he’s right.
And others hold the same belief.
I was watching a programme last week, I think it was on either Bloomberg or CNBC, but anyway, an investor was being interviewed and he was being asked how he was being impacted and what he thought about markets and what would happen etc.
He answered by saying he didn’t know how markets would react to a situation that was still evolving. He then said the value of his own personal fund was down seven figures since the virus took hold. And I’m pretty sure I saw a small hint of a smile come across the face of the interviewer. I think she might have thought, this is going to be a great headline for the next few hours, repeated on a loop every hour, and you know, bad news is really good for viewing figures.
She then asked, how much worse things could become and was it likely that if things continued, he could lose everything.
Despite his loss being >$1,000,000, I don’t think she was expecting what he said next, which was:
I’m not losing a minute of sleep. This fall is based on fear and panic, not underlying financial fundamentals, so I’m holding tight. This storm will pass, I just need to patient and I’ll be fine, and that’s the advice I’m following, and I’d give to anyone watching.
He knows that when markets drop by 25%, there’s a 90% chance they’ll be higher in 5 years’ time, with the average return over those 5 years’ at about +63%.
And if the drop is even higher i.e. 35%, the odds that markets will be rebound in 5 years’ increase to 99%, and the returns that subsequently follow over that time period being +78%.
The importance of holding firm and remaining calm can’t be underestimated, because if you do, and you believe in factual indisputable data, you’ll be fine. You know that similar falls in values have happened 14 times’ in the past 70 years, and on every occasion, markets recovered, with some of the biggest rebounds happening following the biggest losses.
And here’s one last piece of factual data, I thought you’d like to know about, because some people are moving their fund from cash to equities, back to cash a day later, and they’re back and forth making decisions like a tennis ball going over a net during a long rally. One day it’s in the equity part of the court and the next it’s in cash.
If it’s in the cash side of the court for too long, it can ruin your longer term returns. Because if you miss out on those days it should be in the equity side, it reduces your returns. You’re missing out on those days when markets perform very well.
And here’s the factual historical evidence to back up this claim.
If, you stay invested throughout the downturn, you annualised return when markets normalise should be 6%. If you moved to cash and missed out on the top 10 days when markets rebounded, your return would be 2.3%. If you stayed in cash and missed out on the top 30 days of positive returns, your return would be -2% and if you missed on the best 40 days, your return is just under -4%.
The take-away from this, is that in the short term missing out on even a very small number of days that produce strong returns, can ruin long-term returns.
I’ve given you lots of numbers to digest but it’s important you know them because, people don’t know what they don’t know, and they make decisions based on emotion or what a friend or family member tells them. And unfortunately, whilst the advice may be well intentioned, it’s just not reliable or credible. And what they do or don’t do for that matter can take them years to recover from.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at email@example.com or www.harmonics.ie