Financial markets can be quite scary at times. Headlines like ‘$100 billion wiped from the ASX’ can make it difficult to stay the course and remain invested when shares are going up and down like a yo-yo.
Investors sometimes make the mistake of selling when the market falls out of a fear it will continue to go down and never return.
This response is very ‘human’. Research shows people feel the pain of losses twice as much than the enjoyment of profits. It’s our fight-or-flight response, the amygdala part of our brain kicking into overdrive to avoid the potential for loss. People don’t like uncertainty and will avoid risks if possible.
However, acting in this way is more likely to harm your returns than help. You need to remind yourself that short-term market movements and losses have always been followed by longer periods of gains and recovery. Those who resist the urge to sell when markets fall end-up reaping the rewards. Money flows from the impatient to the patient.
Over 100 years Australian shares have generated returns of around 11.5% per year. Getting this sort of return takes a lot of patience and discipline to hold through good times and bad.
Improve your chance of success
Some people try and time when to get in and out of markets to avoid falls. Market timing is tough to get right. Thousands of professional investors are already trying to do this all the time, but even most professionals fail dismally each year. You also risk not being invested when the market rebounds and you might be too stubborn to buy back at a higher price if you’ve been wrong. The best days of market returns often come around the same time as the worst days. If you’re out of the market you risk missing out.
Time in the market rather than timing the market is the key ingredient for investment success. The longer you invest and ignore short-term price moves, the better your chances of making a great return.
This is why we recommend all clients have at least a 3 year investment time frame to improve their opportunity for success.
Over the 3 years to 29 February 2020 our portfolios have delivered returns of 8.7% p.a. (conservative – Amethyst) to 10.6% p.a. (high growth – Topaz).
These strong returns were despite some ups and downs along the way and a 20% fall in the Australian share market in 2015/16.
If you invest in shares for a few weeks, your chance of a positive return is only about 50/50. No better than a coin toss! Keep holding for 3 years and your chance of success is above 80%, invest for 7 years and that increases to over 90%. Diversify into bonds and gold as well (like we do) and it’s higher still.
Over 10 year windows, Australian shares have never had a negative return since records began in 1875! So if you had chosen any 10 year period to invest over the last 140 years, you would have made money every time.
What you can do when markets fall
Here are a few ways you can take advantage of market dips.
Resist the temptation to put all of your money in one place. It’s why we invest across a broad range of different investments because defensive assets like bonds and gold help to protect a portfolio by providing a cushion when markets fall. Diversifying to avoid large losses from a single investment can make a big difference to your mental health when markets fall.
Stick with the long-term plan. Market dips can be a good time to top-up your investments since you’re able to benefit from buying shares at a cheaper price. Setting a regular investment plan can also help manage the risk of market movements and help balance out how much you pay for your investments through dollar cost averaging.
Take a break from monitoring
If you have a tendency to get nervous when your investments go up and down, consider monitoring your portfolios less frequently. This helps prevent your short-term emotions from overpowering the long-term game-plan.
Even though the value of shares might decline over the short-term, these companies will still be paying dividends. When markets fall, dividends and distributions can be reinvested at a lower price, helping you benefit even more when share prices go up again.
For example the Vanguard Australian Shares ETF (VAS) and iShares Core Composite Bond ETF (IAF) will both pay distributions in April 2020 which we will use to re-invest or rebalance client portfolios to keep them on track.
Stockspot makes it easy to grow your wealth and invest in your future.
This article was originally posted in May 2015 and has been re-published with updated information in March 2020.