It has been alarming to read in the media that the recent market turbulence has caused unadvised superannuation fund members to panic and collectively move billions of dollars into cash, unaware of the significant long-term impact it may have on their retirement savings. Not only will these investors crystallise losses by selling when markets are down but many will also lose the opportunity to participate in the eventual market recovery by either staying invested in cash or switching out of cash after markets have recovered.
Although media reports often focus on short-term share market movements, most Australians do not have their portfolios invested entirely in shares. Many of our clients with diversified balanced portfolios (60% growth investments and 40% defensive investments) were surprised when finding out the 12-month net return on their portfolio to the end of March 2020 was around -4% considering the doom and gloom reported in the media. For reference, the S&P/ASX 200 total return index returned -14.4% for the 12 months ending 31 March 2020.
While the current market volatility may be causing investors to worry, it is important to remember the basic principles of investing remain unchanged.
Three tips for successful investing during COVID-19
Work with your emotions
It is unrealistic for most investors to completely set aside their emotions when making investment decisions. Rather than trying to fight against the emotions, it is better to be aware of them and cognitive biases that may be experienced when investing and put these into context to help safeguard against potentially impulsive or irrational decisions.
As explored in our article, The impact of cognitive bias on your investment decisions, cognitive biases that are potentially harmful to investors, particularly in the current climate, include (but are not limited to):
- Recency bias – emphasising recent events over historical events. Recency bias can cause investors to think that a rising market is likely to continue to increase in value or that a declining market will keep depreciating.
- Confirmation bias – interpreting or favouring information that confirms or strengthens your own beliefs. Confirmation bias can cause investors to be overconfident in their decisions if the information they are analysing appears to support their beliefs.
- Anchoring bias – relying too heavily on a piece of information or past event when making a decision. An investor with an anchoring bias may focus on historical prices when deciding whether to buy or sell an investment at the current price without considering the intrinsic value of the investment.
Stick to your long-term strategy
During a market cycle, it is common for investors to be optimistic or even euphoric when returns are positive and to be pessimistic when there is a market downturn. In reality, the peak of the market cycle when investors are feeling positive is the point of maximum financial risk and the trough of the market cycle when investors are feeling despondent is the point of maximum financial opportunity.
Six of the ten best trading days of the S&P 500 Index, which tracks the 500 largest US-listed companies, over the 20 years from January 1996 to December 2015 were within two weeks of the ten worst trading days (J.P. Morgan, 2016). This index returned an average of 8.2% p.a. during this period, however missing the top ten trading days (by being out of the market) reduces this average return to just 4.5% p.a., whilst missing the top 20 trading days resulted in just a 2.1% p.a. return (J.P. Morgan, 2016).
Take the time to reflect on the goals you are trying to achieve rather than on short-term market fluctuations. As has been the case in previous market cycles, investors who stick to their strategy during a downturn are rewarded with above average returns in the long run. As the old saying goes, “It’s not timing the market that allows for investment success, but instead, time in the market.”
Maintain a diversified portfolio
Diversification is an important risk management strategy and means investment success is not reliant on the performance of a single investment.
A diversified portfolio would typically be invested across a range of different investment classes such as fixed interest, shares, property, and infrastructure, both in Australia and globally. The Australian Dollar has tended to fall in times of market/economic stress, which boosts the value of international assets. While the AUD has mostly since recovered, this effect was observed recently, with AUD/USD exchange rate falling to as low as 0.55 during the recent market downturn offsetting losses on international assets. While investing offshore is sometimes perceived as more risky, foreign currency exposure has historically been a useful way of reducing risk in a diversified portfolio.
If you would like to discuss the impact of COVID-19 on your investment strategy, please contact a BDO Private Wealth Adviser.
J.P. Morgan Asset Management (2016). Guide to Retirement: 2016 Edition. Retrieved from https://am.jpmorgan.com/blob-gim/1383280097558/83456/JP-GTR.pdf