At times like these, it’s good to get some perspective.
Australian shares rose 24% last year, touching record highs, and 10% a year over the past seven years. Global shares rose 28% last year and 17% over the past seven years.i After such a good run, many observers have been saying shares were looking fully valued and that a correction was likely.
The thing with market corrections is that it is impossible to predict what will trigger them or how long and severe they will be.
Avoid knee-jerk reactions
At this point, markets are responding to uncertainty. Nobody knows what the extent of the economic fallout will be, so the temptation is to bail out of shares and put your cash in the bank. Or jump ship and switch to a ‘safer’, more conservative option in your superannuation fund.
While the urge to act and protect your savings is understandable, knee-jerk reactions can be a mistake.
It’s near impossible to time the markets. Not only do you risk selling when prices are near rock-bottom, but you also risk sitting on the sidelines as the market recovers. As history tells us it always does.
In an ever-changing world, the basics of investing stay the same. By sticking to some timeless rules it’s much easier to avoid emotionally driven reactions and focus on your investment horizon.
Have a plan
Investing is a lifelong journey and like all journeys you are more likely to reach your destination if you plan your route. Without a plan, it’s easy to be distracted by the latest market worries and short-term price fluctuations.
Think about your personal and financial goals and what you want to achieve in 1,5,10, 20 years’ time. Be specific, put a dollar figure on your goals and plan how to reach them.
Low risk comes with lower returns
Many people are wary of investing in shares because of the perceived risks. Growth assets such as shares and property do entail higher risk than cash in the bank, but they also deliver higher returns in the long run.
Perhaps the biggest risk of all is not earning the returns you need to achieve your goals. While domestic and international shares produced stellar returns last year, cash returned just 1.5% which was below the level of inflation. Cash returns were not much better over the past seven years, averaging 2.2% a year.
Spread your risk
Shares, property, bonds and cash all have good years and bad. While shares and property tend to provide the highest growth over time, there will be years when prices fall or go sideways. In some years, bonds and even cash produce the best returns.
A good way to reduce volatility and enjoy smoother returns over time is to diversify your investments across and within asset classes. That way, one bad investment or difficult year won’t sink your ship.
The most appropriate mix will depend on your age, the timing of your goals and your risk tolerance. You will need cash for emergencies and short-term goals, with enough money in growth assets to last you through your retirement.
Let your savings grow
The effect of compound interest is often referred to as magic, but there’s no trickery involved. Better still, it requires no work on your part, just the willpower to reinvest the income you earn on your investments, so you earn interest on your interest.
Rather than sell shares in quality companies in a panic, you could continue to collect your share dividends and reinvest them in more shares or other quality assets. This way, you avoid crystallising short-term paper losses and benefit from the inevitable market recovery.
That’s the simple but powerful concept behind superannuation which locks away your savings and all investment earnings until you retire.
When fear is driving markets, it’s important to get back to basics and think long term. If you would like to discuss your overall investment strategy, don’t hesitate to get in touch. Call our financial planners on 03 5434 7600.