Preparing for Volatility

Share This

Share investors have had a great run over few years, despite the sharp dropped which occurred at the beginning of the COVID epidemic. There’s been a combination of massive injections of Government money into the economy, low interest rates, strong economic growth and constrained overseas travel which have seen investors awash with cash pour money into shares for good returns.  In December 2018, the S&P 500 index was around 2400. After rising to around 3300 in February 2020, it dropped sharply to around 2300 in March of that year with the emergence of COVID. Thereafter came a rapid rise which peaked at about 4700 in December 2021 – that’s a rise of over 200% in just 21 months. Since then, there has been what is termed a ‘market correction’ with the index dropping to around 4380 today.

Now that unemployment rates have dropped and company profitability and economic growth have stabilised, the threat to world economies is not recession but inflation. It’s time to take the foot off the accelerator and put the brakes on. That means tighter monetary policy and higher interest rates. Alongside this the world political situation has changed and presents risks which could interfere with global economic growth. We are entering a new phase. The recent volatility in share markets is a timely reminder that we need to prepare for the next market correction. There is more volatility to come.

Volatility is a new experience for investors who have known nothing but stable markets in recent years. KiwiSaver balances are building up to a level where regular contributions will not be sufficient to offset a drop in unit prices and it will be interesting to see how investors react to their balances falling. There will be plenty of opportunity over the next two or three years for nervous investors to make bad choices about how their funds are invested.

Let’s be clear on a few basics. Volatility is the reason shares provide higher rates of return than bank deposits. It is nothing to be afraid of; it just needs to be managed. There are two key principles for managing volatility. The first principle is, your investment in shares must be diversified to reduce risk. The second principle is, you must match your investment strategy to your investment time frame. When investors lose money by investing in shares it is because one of these investment principles has been violated. If you are in KiwiSaver, diversification is covered off by your fund manager – no worries there. However, your choice of investment option is critical and it must match your investment time frame.

The problem is, many investors haven’t thought through what their investment time frame is. It is probably not the time at which you retire. Young KiwiSaver members have an opportunity to use KiwiSaver funds to purchase a first home. In that case, their investment time frame is the time at which they expect to withdraw their funds to use as a house deposit. The shorter that time frame, the less exposure to share they should have in their KiwiSaver fund. For most other investors, KiwiSaver and other long term funds will be spent at some time during retirement, but not necessarily at retirement. If KiwiSaver is your principal means of saving for retirement, it would hardly make sense to spend it all at the time you retire. The plan should be to spend it gradually over the course of retirement. Given that the average 65 year old lives to around 90, this means you will continue to invest for many years after the day you retire. A sharp fall in the share market just before you retire should not be a major concern.

For investors with a long time frame, short term volatility is nothing to worry about. Good fund managers will find opportunities to buy shares cheaply during a market downturn. The best returns are made by buying at a low price and selling at a high price. Inexperienced or nervous investors do the opposite; they buy near the peak when everything looks good, then panic and sell when the market drops.

In times of volatility, always review your investment goals and investment time frame. If they haven’t changed, then you shouldn’t need to change your investment strategy, unless it was flawed to begin with. Make sure you have access to funds in stable investments such as bank deposits to cover your short term spending, so you can ride out the changes in volatile investments. Then sit back and relax.

Related Articles

Liz Koh

Responsible Investing

There is a worldwide trend for investors to want to make a positive contribution to the world by investing in companies that are socially and environmentally responsible. If you are passionate about the effects of climate change, the scarcity of food and water, and social or environmental policies in general, then you will no doubt wish to ensure that the companies in which you invest are going about their business in a manner that is consistent with your views.

Read More »

Stay in the loop

Keep up to date with the latest developments from Enrich Retirement