Investors in shares or diversified funds such as KiwiSaver are on a rollercoaster ride. The best strategy for dealing with volatility depends on your financial goals and whether you are still building your wealth or using it to fund your retirement.
For wealth accumulators, market volatility is more of an opportunity than a threat. Regular contributions into KiwiSaver and other investments when markets are moving up and down produce an effect called ‘dollar cost averaging’. This simply means that when you are contributing a regular fixed dollar amount, you will buy more units when prices are low and fewer units when prices are high. If you are a wealth accumulator, a market crash is an opportunity to invest more at a low price.
However, the effect of a market crash on retirees wanting to make regular withdrawals has the opposite effect. When you are taking income from your investment portfolio, you are selling units regularly, not buying. You need to have a plan in place to make sure you aren’t forced to sell investment units when prices are down. This type of investment risk is called ‘sequencing risk’. Sequencing risk occurs when you regularly withdraw amounts from your portfolio.
Retirees are much more exposed to sequencing risk in the early years of retirement. A crash in the early years when large withdrawals are being made will have a lasting effect on the performance of an investment portfolio. This risk can be lessened by setting up a laddered portfolio of bonds or term deposits in the last few years before retirement to ensure there is enough cash on hand for the first few years of retirement. Alternatively, investing a lump sum in a variable annuity will give an income for life which is guaranteed regardless of what happens in investment markets.