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When sharemarkets fall and people start panicking about their investment and personal finances, it’s easy to think the best solution is to sell your investments or switch your super fund investment option to a less volatile one like cash.
But while it might make you feel more in control, doing it is a decision that could cost you dearly.
Rather than locking in your losses, here’s why now may not be the time to make a change.
Staying calm when you feel like panicking
For most people, the best thing to do with your super after a major fall in investment markets is to do nothing at all. As the old adage goes, it’s a bit like trying to shut the gate after the horse has bolted.
A key lesson many super savers learnt in the wake of the 2008-09 GFC market decline was that switching your super fund investment option after a major market correction can cost you dearly.
As Industry Super Australia’s (ISA) chief executive officer Bernie Dean explains, one sure way to lose money in super after a downturn is “to make changes that crystallise your losses”.
In other words, when it comes to your super, the best course of action is no action at all.
“People avoid selling their house during a property market slump because they are worried about making a loss. The same principle should be applied to changing your super fund or investment option immediately after a market drop,” says Dean.
It’s a mistake he is keen to stop fund members repeating, arguing investment markets will eventually recover. “It is understandable that people are concerned about the impact coronavirus is having on the economy and their super balance, but it is important to remember that super is a long-term game and the market recovers.”
How much could crystallising a loss cost you?
The actual cost of realising or crystallising an investment loss depends on lots of different factors. These include the amount you have invested, the investment option you swap to, and whether you move your money back before the market starts going back up again.
ISA research shows that after the last major market decline (during the GFC), fund members in an average industry super fund who moved their money from the Balanced investment option to their fund’s Cash investment were considerably worse off.
Vanguard Investments has also crunched the numbers to show the impact of realising your losses, versus leaving your investment portfolio untouched after a significant market decline.
The graph below shows the trajectory of an investment portfolio from 1 November 2018 to 28 February 2019, with four different investment decisions taken at the end of December 2018 when the market experienced a downturn. It shows the impact on a hypothetical investor of leaving their investments in place after a market downturn, cashing out at the market low, cashing out a week later, and cashing out then reinvesting a few days later.
Source: Vanguard US calculations, based on data from FactSet, as of 28 February 2019.
The Vanguard calculations show by remaining invested and not selling at the market low in December 2018, the investor regained 4.2% in just two months.
Cashing out at the December low, on the other hand, meant the portfolio was nearly $100,000 less than what it could have been by February 2019.
Even if the investor cashed out at the end of December and then reinvested a few days later, the value of the portfolio was still not as high as if they had stayed put.
Missing the rebound can cost you dearly
The Vanguard graph also shows that if you realise your losses after a market decline, not only do you make a paper loss a real one, you can also miss out on the market rebound.
After a significant downturn in the sharemarket, history shows there is usually a sharp rebound. This usually occurs before most investors are confident enough to venture back into the market or switch back into a more growth-oriented investment option.
To illustrate this, AMP Capital’s chief economist Dr Shane Oliver compiled the table below showing how the Australian sharemarket has rebounded after each bear market (a 20% decline not fully reversed within 12 months) since 1900. The final column shows the size of the rebound over the first 12 markets from the market low, with the average rebound being 29%.
Based on the All Ords. Source: Global Financial Data, Bloomberg, AMP Capital
The table shows super fund members who switched into a Cash investment option during the GFC missed out on the 55% sharemarket rebound that occurred in 2009. In the short run they felt relief about avoiding ongoing volatility as sharemarkets stabilised and then recovered, but their investment returns quickly fell behind those achieved by fund members in growth-oriented investment options.
Simple strategies for a bear market
Although investment markets may not be booming, investors and fund members may want to take advantage of the cheaper asset prices on offer. Some strategies to consider could include:
1. Think about dollar cost averaging
With dollar cost averaging, you invest the same amount of money into your super fund, sharemarket or investment fund at regular intervals over a long period – regardless of whether prices are up or down.
By investing regularly and ignoring the current market price, you average your entry price and avoid making a potential mistake by investing a single lump sum at the wrong time.
When fund members have a super contribution paid into their super account on a regular basis, they are using a form of dollar cost averaging.
2. Ensure you’re properly diversified
Diversification and discipline are vital during and after a dramatic market downturn. Holding a well-diversified portfolio can help smooth out investment losses over the long term, which is why super funds emphasise the importance of holding a mix of growth assets (shares and property) and defensive assets (cash and bonds).
Ensuring your portfolio is properly diversified is essential if you are looking to re-invest when markets are volatile. Just as COVID-19 has affected different countries in different ways and at different times, different investment markets and regions are likely to rebound at different points in time.
No one can predict exactly when this will occur, so it makes sense to spread your investment dollars across different assets and regions.
3. Rebalance your investment portfolio
A major market decline can throw off the target allocation of assets in your investment portfolio, so it’s sensible to consider rebalancing back to your portfolio targets. Otherwise, you may be exposed to more risk than is suitable for your risk profile.
Rebalancing helps keep you focussed on the big picture of your overall goals, risk tolerance and investment time horizon, rather than on big movements in the financial markets.
Super funds regularly rebalance their overall investment portfolio and the assets within each investment option to ensure they remain in line with their strategic allocation plan, so it makes sense for small investors to follow suit.
4. Talk to a financial adviser
If you are concerned about your super savings or your financial position more generally, now could be a good time to get some professional advice. An independent, professionally qualified financial adviser can help you structure or review your investment portfolio or super to take advantage of the current investment environment.