Back to basics: avoiding the day to day temptation to time the markets
06 February 2018 | Investment principles
The best of times can also be the most worrying of times for investors.
As we head off on the journey that is destined to become 2018, investment markets have been both kind and – until this week at least - relatively benign.
Suddenly headlines are screaming at us about the billions lost off market values and record one-day drops in the US index.
The motional tide of markets can turn rapidly so let's take a moment to remind ourselves of the returns delivered across the major asset classes (as measured by the Vanguard suite of index funds) in 2017 along with the returns for the past five years to December 2017.
|Asset class||1 year return%*||5 year return%*|
|International shares (currency hedged)||20.2||15.7|
|Australian fixed interest||3.7||4.2|
|Australian listed property||6.8||13.5|
|International listed property||0.7||14.1|
|International listed property (hedged)||6.85||10.7|
* To December 31, 2017
Without doubt there are investors – particularly those who have SMSFs in pension mode – who would have been happier if the returns on cash/fixed interest had been higher, but overall the past five years has been good for investors.
But after markets have had such a strong run it is reasonable for people to start questioning whether the good times will end any time soon. Forecasting the future performance of markets is a fraught business. The only certainty is that markets do move through economic cycles so at some point there will be market shocks and downturns that we will all have to deal with on our investing journey.
There is no question that sharemarket valuations – particularly in the US – are stretched given the run up in prices. This is all grist to the mill of media commentators speculating on when or what may cause the run to end or spark the next sell-off.
The real challenge for investors is deciding what action – if any – they should take.
You can – as some commentators have suggested - sit around monitoring brokerage screens with one finger poised over the sell button...
That sounds stressful and captive to the market's emotional swings. The reality is that no-one sends you an email alert or rings a bell when the market has just peaked – or at least not one guaranteed to be correct. And while you are sitting at home on your screen it is worth remembering there is an army of professional investors out there – including 150,000 Certified Financial Analysts globally – who are doing the same thing, but with all the resources that financial services organisation can provide to support and inform their work.
Which brings us back to the basic question of what investors can do.
First port of call is to talk to your financial adviser – if you have one.
Not everyone does but one of the undervalued benefits of having an adviser is the coaching and portfolio review they can provide through periods like this. That does not mean they have any magical answers but they can provide a professional, unemotional review of your portfolio. As investors we can often get emotionally invested in what is in the portfolio so an impartial opinion can be instructive.
While you may not have an adviser you should still have a written financial plan that sets out the reasons you are investing, long-term goals and appetite for risk.
Too many investors focus on return projections - which are notoriously unreliable - and do not spend enough time thinking through what level of risk or loss they can bear.
For example, your age is a key input into these type of considerations simply because people approaching or in retirement typically are much more sensitive to significant market drops and potential capital losses.
All of which feeds into your portfolio's asset allocation levels which are one of the most important decisions you make as an investor.
The simple act of reviewing and rebalancing your portfolio is a practical step you can take at times of market uncertainty. After five years of strong markets it is likely that some of the allocations will have moved outside the target allocations if rebalancing has not been done regularly.
This is a great discipline for investors but be warned, it can present an emotional challenge. Essentially if one part of your portfolio has performed strongly – hedged international shares for example – it is likely to now be above your target asset allocation level. So the disciplined act is to sell some of it down and invest the proceeds in the part of the portfolio that needs topping up.
In raw terms that means selling winners and buying losers – which is why some people intuitively find the notion of rebalancing hard to act on.
Tax consequences can also play a role here if you cannot use additional cashflow to rebalance the portfolio so again getting advice is an important input.
Part of the value of rebalancing is that it is a reason to revisit the basic reasons you are investing in the first place, your long term goals and whether or not you are on track. Staying within your target asset allocation means that you are managing the risk/return tradeoff within the portfolio to what you are comfortable with.
When combined with broad diversification across the asset classes the discipline of rebalancing can help keep investors on course to meeting their long-term goals and avoid the temptation of reacting to short-term market volatility and emotive headlines.
Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.
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Robin Bowerman, Principal, Market Strategy & Communications at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.