How to stay calm in stormy times

Look at the big picture - invest for the long-term

If you own a house, you wouldn't sell it if you read in the press that property prices may be falling. Nor would you have it valued every day.

However, when it comes to shares, some people panic and begin selling during market downturns. Whilst the market volatility that started to affect our investments in September 2007 is now part of a global economic crisis, before you make any decision about changing your investments, read on:

The foundations of the Australian economy are sound

Whilst this is a crisis, we are now at the point where reactions are being driven by sentiment, rather than economic reality. In other words, investors are panicking and reacting to the substantially negative media reporting on the outlook for the economy. There are positive local factors you should consider when reviewing your investments:

  1. The Australian financial regulatory system is now being heralded as the optimal model for developed nations.
  2. Crucially, the banking sector is very strong, thanks to the level of regulation in existence. All our major banks are highly profitable and of the 20AA rated banks in the world, four are here in Australia.
  3. We have low unemployment (4.4%)¹, a big government surplus and inflation is under control.
  4. Whilst the Chinese and Indian economies will not survive the credit crunch unscathed, urbanisation in those two giants should continue at speeds sufficient to underpin demand for Australian resources.
  5. Our government is in continued consultancy with regulatory bodies both locally, and globally, and is making changes as required to support our economy.
¹Source: Investment Solutions as at 30 November 2008

Market volatility & extraordinary stockmarket events are cyclical

History shows us that markets are volatile - so it's unrealistic to expect that the 5 year outstanding performance in the lead up to July 2008 could be sustained.

There is no doubt that growth assets (shares and property) performed poorly during the past twelve months, as the global financial crisis deepened. Annual investment returns were the worst in recent years, with the Australian sharemarket down 38.4% over the twelve-month period to December 2008.

However, as sharemarkets rise and fall, it's important not to panic or be distracted from your long-term investment goals. Seeing your investment falling in value, particularly after several years of solid growth can be unsettling. But it's important to remember that a bear market, a term which commonly describes when investment markets are falling, accompanied by widespread negative investor sentiment, is part of the normal cycle of investment markets. We have been through bear markets before, and markets have always recovered.

Consider the facts from previous significant downturns:

  • The market took 6 years to recover from the 1987 crash - when markets fell 50%
  • It took just over 1 year for the market to gain back the losses recorded after the 1994 bond crisis (markets fell 22.03%)
  • The post world Trade Centre attack & the Iraq invasion at the start of the decade lasted nearly 3 years - but were followed by a boom that saw Australian shares rise 141%.

The graph shows how the sharemarket has gone on to deliver positive returns over the long-term.

market volatility graph
Source: Investment Solutions, Bloomberg. * The S&P/ASX Accumulation Index was introduced in May 1992, prior to this the ASX All Ordinaries Accumulation Index was used. This chart is based on an initial investment of $10,000 in each index as at 1 December 1985

Withdrawing after a market downturn may cause you to realise a loss from your original investment.

Let's say you invested money just before the Tech Wreck in 2001 and then sold out just afterwards because the market fell. You would have got back less than you originally invested and missed out on the market gains that followed.

Source: S&P/ASX200 Accumulation Index to 31 December 2008, Investment Solutions, Bloomberg

Time is on your side—the sharemarket is a recommended long-term investment

Hang in there. History tells us that the longer you stay invested in the sharemarket, the lower your chance of losing money:

Source: St.George Investment Solutions. Benchmark based on the annualised return of the S&P/ASX200 Accumulation Index (the S&P/ASX200 Accumulation Index was introduced May 1992, prior to this the ASX All Ordinaries Accumulation was used) over 1, 5 and 10 years on all eligible time periods to 31 December 2008.

Time in the market, not timing

Strong market gains often occur after periods of weak performance. Large falls tend to follow strong returns. If only you could buy when share prices reached their lowest point and sell when they peaked - you'd be rich! But even the most highly trained professionals - with all the data available to them - can't consistently pick market turning points.

The risk you take trying to time the market will often outweigh the extra return you might generate. Instead you might find that by simply staying in the market you could generate a superior long-term return. Look at the difference in your return if you'd held on to your investments for the whole period compared to selling your investments and missing the best 10, 20 or 30 days. Download our "Do less make more" flyer for more detailed information.

Source: Datastream & Investment Solutions at 31 December 2008. *S&P/ASX200 Accumulation Index was introduced May 1992, prior to this the ASX All Ordinaries Accumulation was used.

Ways to make market volatility work for you

1. Smooth a bumpy ride - keep it regular!
By investing a set amount regularly, you're effectively buying fewer shares when the prices are high and more shares when prices are low. This means you average down the price per unit of your investment, which in turn means you need less growth before you make a profit.

Regular investing removes the emotion from the investment decision and ensures you don't get caught up in the market hype and 'noise'. It also helps you avoid buying when the market is peaking or selling just before a boom.

Right now, your regular investment would be taking advantage of the low prices of previously overvalued stocks. In other words, just like the year end sales - you can buy more with less money! Download our flyer for more detailed information

2. Diversify, diversify, diversify
One of the most reliable ways to maximise your long-term returns and reduce the risk of losing money is by diversifying your investments - spreading your money across different asset classes, regions, sectors and investment managers increases your chance of having some exposure to the best-performing investments. Here's a simple example of diversification:

You live on an island whose entire economy consists of two companies: one that sells umbrellas and another that sells sunscreen.

You invest only in the company that sells umbrellas. You get good returns on your investment during the rainy season, but poor returns in the dry season. Maybe you should invest in the sunscreen company instead? But by doing that your returns would be good when the sun is out, but will tank when the clouds roll in.

To minimise the weather-dependant risk, you should split your investment between the companies. With this diversified portfolio, your returns are decent no matter the weather - because the good returns on one investment will help compensate for the bad returns from the other. Download our flyer for more detailed information.

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