IF YOU'VE been looking at the value of your investment or pension
funds over the past couple of weeks it might make for uncomfortable reading and for some it can be hard to make sense of what’s going on and what they should be doing given what’s going on with the war in Iran and the impact its having on energy prices and markets.
Since the war began on the 28th February, to the date I’m writing this which is the 26th of March, markets have reduced in value but perhaps not by as much as people might think. We hear the market is in freefall and tumbling and this might be correct for some sectors but not for all and if your portfolio is diversified the impact is not as great as you might think and I’ll come back to the importance of diversification later in this article.
Before I do, the following are examples of what a typical managed fund with different risk ratings have fallen by during that time period from 28.02 to 26.03 which is 19 working days:
Risk Rating 2 -0.90% Reduction per day -0.048%
Risk Rating 3 -1.34% Reduction per day -0.071%
Risk Rating 4 -1.98% Reduction per day -0.104%
Risk Rating 5 -2.46% Reduction per day -0.129%
Risk Rating 6 -5.23% Reduction per day -0.275%
And there are funds that haven’t reduced by as much as you think. Tech for example had increased by +1.50% up until about a week ago but now stands at -0.73% over the past 19 days.
And when you look at what’s happened to gold, its value drop by -11.15% in the last 19 days.
And if we look at specific stock market indices you would find the following:
The S&P 500 YTD is -5.56%. The NASDAQ 100 is down -6.42% for the year, and The STOXX 600 is now -3.51% year to date
And for some context here, these YTD drops are very normal numbers when you look at the average movements for equity markets. The drops we are experiencing in recent weeks appear bigger and out of the ordinary and that’s because the reasons behind the volatility are very visible and everyone can see and hear the reasons why.
So, markets have been down over the past few weeks but if you look at how markets have performed over a long period of time and when you do returns have been positive.
To show you what I mean let’s look at the performance of those funds I just referred to and put in another couple of columns where we’ll look at how they have performed factoring in the recent reductions we’ve seen:
(19 Days) 1 Year 3 Years 10 Years
Risk Rating 2 -0.90% +2.03% +11.86% +15.39%
Risk Rating 3 -1.34% +4.46% +20.58% +40.38%
Risk Rating 4 -1.98% +7.78% +34.84% +94.64%
Risk Rating 5 -2.46% +11.97% +53.60% +164.20%
Risk Rating 6 -5.23% +13.43% +66.95% +221.59%
So, you could take a view that if you have a fund that has a risk rating of 4 that its down -1.98% or you could take the view that its +7.78% over the past year.
If you’re looking at the fund in the short term you’ll feel you’ve lost money but if you stretch that view from 19 days to 365, you might feel better given that your fund has risen in value by nearly 8% so I guess it depends on what your perspective is and over what period of time you want to measure performance over.
And don’t forget that when you account for tax relief and despite negative returns your fund will have increased by more than what you personally put in.
If someone for example set up a pension 19 days ago and invested €100 into a fund with a risk rating 6, that €100 would now stand at €94.77. But if that person’s marginal tax rate was 40%, the €100 they invested would have personally cost them €60.
So, despite their €100 having reduced to €94.77, they only put in €60 and even though their fund is down 5.23%, they’re still up 58% from what they personally put in.
Having said all of that there’s one thing we can predict with a great degree of certainty about the stock market and that is, it will rise and fall. We just don’t know by how much and that’s because the reasons behind the impact i.e. economic events or wars or natural disasters (including pandemics) are very hard to predict.
But here’s some interesting numbers. When the dotcom bubble of 2000 to 2003 burst, markets dropped by as much as -47% and it took 1,515 days before that loss was recovered.
When the global financial crisis hit between 2007 and 2009, some markets declined by -56% and it took 1,286 before they recovered. And when the Covid-19 pandemic occurred, markets dropped by -34% but that loss was made good in just 141 days.
So looking back through history each market decline has its own unique story but the key lesson we can learn from each is that tough times don’t last forever and markets do eventually recover their losses.
And on average it takes around five months for a correction to bottom out, but once the market reaches that point and starts to turn positive, it recovers in around four months. And a correction is defined as when there is a drop in value of over 10% and less than 20%.
Losing 5% or 10% or 20% or even more can obviously be damaging for anyone, but it can be more problematic for people who near retirement and my advice to them is to move your fund into cash and take away the uncertainty from you especially if you’re close to activating your fund. But everyone should be looking at their pension funds regardless of their age and the following strategies can protect your pension fund from the dangers of stock market volatility and will help make losses less dramatic.
Keep a diversified portfolio: which means investing in a wide variety of assets. This includes stocks and bonds across different geographical regions and asset classes. And different types of investments can have little or low correlation which means they don’t move in sync with one another. When one asset class declines, others may hold steady or even rise, reducing the overall impact of market declines on your portfolio.
Don’t try to time the market: please avoid the temptation to cash out your investments when the market dips and then trying to figure out when you should re-enter.
Rebalance your portfolio: a long period of growth especially for equities can skew the balance of your fund towards riskier assets. By selling some of those higher risk but higher growing equities and replacing them with less risky investments, you’ll minimize the impact of a stock market downturn
So, what have we learned from other events in the past that caused markets swings and the answer is that it’s impossible to predict how long a stock market recovery will take. But we also know that if you don’t panic and sell your stock holdings when the market crashes, you will be rewarded in the long run.
And this is true when it comes to all other historical market crashes. Sure, they have lasted for varying lengths and had different levels of severity, but with all, the market always recovered and went on to new highs.
And I completely understand and get how it’s easy to get nervous during times like this, of course it is, but you can’t lose sight of what your investing for and for how long and the key might be holding your nerve and sitting on your hands and staying patient.
Investors who are confident that their fund is still aligned to their risk profile, don’t micro-manage their portfolio every day. They barely even look at it because they know that 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.
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 4% and 8% per annum depending on their risk profile.
Whenever I’m in doubt about anything I look at data and the past to see what happened when markets fall for whatever reason. 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.
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 as one of the greatest investors of all time, Warren Buffett, said, stock market is a device for transferring money from the impatient to the patient and he’s right. And others hold the same belief.
My key message is to be patient and once you’re happy that the fund your invested in continues to match your attitude to risk and return I’d say don’t change it, because if you stay invested over time it will produce the outcome you’re looking for.
And it’s easy for me to say be calm and don’t panic when we don’t know what’s ahead, but what we do know is that what’s happening to markets right now has happened before and there are patterns we can learn from. And the biggest one is that despite day to day volatility the long term returns of investing in equities is incredibly consistent.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie
