We all need to deal with the inherent uncertainty of the world in which we live, no matter what our age. Older investors have traditionally felt the need to take less risk than younger ones, particularly when they have retired. This is usually achieved by having greater exposure to cash and fixed interest investments.
However, as I have written previously, with our historically low level of interest rates, these ‘safe’ investments also carry a type of risk. As the returns after tax and inflation are close to zero (or below zero), these investments increase the risk of you running out of money before you die. Over recent years, as interest rates have fallen, many older investors have opted to increase their exposure to other assets such as domestic and international shares.
Given the recent correction in these markets (of between 10 and 12 per cent) in the past week or so, should investors be regretting the decision to have exposure to share markets?
The reaction of markets in the short term is to uncertainty about the future rather than the immediate facts. How far will the virus spread? How many people will it infect? How many people will die? If China has to shut down production for an extended period, what happens to supply chains around the world?
At this point, no one can really answer these questions and as a result some investors are abandoning share markets and moving back into cash and fixed interest. The general thinking is probably that ‘I am better off with a small negative return than a large negative return’.
The problem with getting out of markets, though, is deciding when to get back in.
There is an old and well accepted adage about investing – ‘it is time in the markets rather than timing markets that produces the best long-term returns’. My personal preference is to stick to my long-term strategy and to ride out these periods of uncertainty. Like the previous viral epidemics, there is always a level of concern and even panic often fuelled by the media (including social media) which typically thrives on bad news.
Previous epidemics have been followed by a peak in the spread of the virus, followed by a dramatic reduction and eventually it is contained and vaccines become available. In other words, even though in the short term the news looks very concerning, there is unlikely to be permanent damage to capital markets and there will be a very quick recovery in share markets in due course.
You should also remember that the coronavirus is just the current trigger for uncertainty. There are plenty of other triggers in our uncertain world, including geopolitical risks, trade wars, climate change, terrorism and rapid technological change which will all raise their ugly heads from time to time.
Furthermore, it is likely that governments and central banks will react by introducing fiscal stimulus and reducing interest rates, which will ensure that when markets do recover they are likely to recover extremely quickly. For those who have exited (or are thinking of exiting) markets it is very difficult to get back in at exactly the right time. Accordingly, I suggest you remain invested and ride out this current period of uncertainty.
I note that a number of the larger fund managers including the industry superannuation funds are looking to take advantage of these short-term declines in markets by increasing their exposure to equities. In other words, the smart investors who are able to take a long-term view can take advantage of these downturns and buy assets significantly more cheaply than just a month ago.
Personally, I plan to do the same thing by using cash reserves (which are currently earning less than nothing) to top up my equity holdings while assets are so much cheaper. I may not ‘pick the bottom’ – that is, buy precisely when stocks are at their very lowest price – but I don’t care.
This approach to asset allocation requires a level of discipline, though.
I have previously decided on my preferred exposure to Australian and international equities. As markets rise and my exposure to these assets also rises, I will reduce my exposure from time to time back to my preferred level. Conversely, if market prices fall and my exposure falls below my preferred level, I will increase my exposure.
This is looking like a time for me to increase my exposure to equities. If you continue with this process in a disciplined manner over time you will be on average reducing your exposure when markets are higher and increasing your exposure when markets are lower, thereby improving your longer-term returns.
Unfortunately, human nature dictates that it is difficult to sell things that look like they’re going well and even more difficult to buy things that look like they’re going badly!
However, remember the advice of the most famous of long-term investors, Warren Buffett, who says that share markets are effectively a mechanism for transferring wealth from the impatient to the patient. Now is a time to be patient, ignore the noise from the media and stick to your long-term plans.
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