When markets fall by as much, and as quickly, as they have recently, it’s easy to conclude that it’s time to move all your assets into the safe haven of cash or something tangible like property. For those nearing retirement, these kinds of concerns are even more heightened, as many trustees watch money they thought they would have to live on in retirement, dwindle overnight.
However, even though this is probably a once in a century event, and one we’re not sure how is going to end at this stage, it is extremely unlikely that it is going to prompt an end to capital markets as we know them.
Therefore, we need to assume that markets will recover at some point. Already, the ASX/S&P 200 has recovered from the low of 4546 reached on 23 March 2020. While nowhere near the high of 7162 reached on 20 February, the index has since recovered to 5311 on 1 May at time of publishing.
Lessons from history
The oft-quoted maxim when markets take a dive is, “It’s not about timing the market it’s about time in the market”. While that may seem trite – particularly if your superannuation balance has just been decimated – it is important to take a look at history and how markets have recovered over time.
AMP Capital head of investment strategy and economics and chief economist, Shane Oliver, has been analysing market data as part of his role for nearly two decades. He’s worked through the tech bubble and the global financial crisis and his analysis of over 100 years of market data is telling.
The following chart shows how $100 would have performed if invested in various asset classes in 1926 (with all dividends, rents and interest earned reinvested).
Source: ABS, ASX, Bloomberg, REIA, AMP Capital
There are obvious blips, like the decade between 1926 and 1936 when Australia was experiencing the Great Depression. But by the end of that decade, $100 invested in Australian equities in 1926 has nearly quadrupled.
In other analysis, Oliver has calculated that since 1900 Australian shares have experienced 18 bear markets. He defines a bear market as a 20% fall that is not fully reversed within 12 months. Therefore, our current correction is not yet included. If it were, and we suspect it eventually will be, then Australian shares would have experienced 19 bear markets in 120 years.
Aside from a 59% fall over a 20-month period from Jan 1973 to September 1974 during the oil crisis and 1970s recession, our biggest bear market has been during the GFC, when markets fell 55% between November 2007 and March 2009.
What’s the point of all this number crunching? Well the following chart should help. This is what would have happened if, at various times during the past 100 years you had changed investment strategies as a result of a bear market and switched into cash at that point.
Source: ASX, Bloomberg, AMP Capital
Basically you would have been $409,641 worse off from switching. Unfortunately none of us started saving for our retirement way back in 1928, nor do we have 90 years to see our superannuation balances flourish exponentially from current falls.
But these charts are illustrative in that they highlight the damage that can be done from shifting into defensive, or lower performing assets as, or after, markets fall. At that point market losses are crystallised and then there is the added difficulty of timing when to reinvest funds in growth assets. Many who do shift to cash miss the market rebound out of a correction.
What to do instead?
Many of the strategies involved in avoiding portfolio disruption during a correction involve foresight but it’s worth having a look at them here. First, it is prudent for any SMSF trustee to be involved in investment strategy and asset allocation reviews at least annually and preferably twice a year. These reviews should help trustees determine if their asset allocation is right for them and their varying retirement or accumulation needs.
One outcome of the current market cycle may be the realisation of just how heavily portfolios were allocated to growth assets. The ‘balanced’ investment options of some large superannuation funds had as high as a 70% allocation to equities. Equity markets had a very good run prior to 21 February 2020 and many growth-oriented SMSF portfolios benefited greatly as a result. The recent correction is a reminder that nothing rises forever.
Dollar cost averaging
One of the more recognised strategies for dealing with market volatility in portfolio asset allocation and acquisition is dollar cost averaging. This refers to the practice of acquiring assets over a period of time, instead of all in one trade, ensuring price volatility is smoothed.
An example
DCA SMSF decided at the beginning of 2020 to increase their exposure to BHP and buy 400 shares. However, instead of buying them all at once, they made the decision to buy them over four months – in 100 lots every month starting on 10 January 2020.
Date BHP share price Cost of 100 shares 10 January 2020 $39.90 $3,990 10 February 2020 $38.40 $3,840 10 March 2020 $29.25 $2,925 9 April 2020 $31.50 $3,150 Total cost $13,905 Average price $34.76 If the trustees had decided to buy 600 shares in different sized allotments the results would have been as follows.
Date BHP share price Cost of 100 shares Cost of 150 shares Total cost 10 January 2020 $39.90 $3,990 $3,990 10 February 2020 $38.40 $5760 $5,760 10 March 2020 $29.25 $2,925 $2,925 9 April 2020 $31.50 $4725 $4,725 Total Cost $17,400 Average price $34.80
In both examples the average share price of BHP was lower than if the whole 400 or 600 shares had been acquired in January when the decision to allocate more funds to BHP had been made. A dollar cost averaging strategy can lower the cost of an investment without trying to actively market time.
For SMSFs, purchases of a pre-determined amount of an asset (decided at the investment strategy meeting) could be made with regular quarterly superannuation contributions.
The directive in the meeting minute could look something like this.
DCA SMSF will increase its allocation to growth assets via an allocation of approximately 400 shares of Computershare and 400 shares of National Australia Bank. The acquisition will be made via a dollar cost averaging strategy and one hundred shares in each company will be acquired with funds from superannuation contributions each quarter over a 12-month period.
The bottom line
Market timing is a very difficult game and one that even the best of professional investors struggle with. Warren Buffett, chairman of Berkshire Hathaway, one of the largest financial services company in the world, had this to say about market direction in February in an interview following the release of his annual shareholder letter.
“You really can’t predict the market by reading the daily newspaper, that is for sure. And you certainly can’t predict the market by listening to me.”