Mistakes to avoid when markets are turbulent

Decisions made in response to short-term events will invariably have negative long-term consequences, so avoid these three common mistakes if you can

Another day, another big fall on global stock markets.

That was the story late last week as Australians woke to the news that a surge in U.S. annual inflation data to a 40-year high of 7.5 per cent had sent markets into the red.

The U.S. market ended Thursday’s trading session down almost 2 per cent, while the Australian stock market followed that lead on Friday, finishing around 1 per cent lower.

It’s understandable that heightened stock market volatility can be very unsettling for investors.

And there’s a reasonable chance that markets will remain volatile over the medium term as central banks around the world move to lift interest rates to counter rising inflation.

Higher interest rates reduce both spending and borrowing power, which impact consumers and companies, and tend to soften flows into riskier investment segments.

Three mistakes to avoid

The first thing is not to be spooked into making rash investment decisions on the basis of day-to-day movements in markets.

Decisions made in response to short-term events will invariably have negative long-term consequences.

1. Failing to have a plan

Investing without a plan is an error that invites other errors, such as chasing performance, market-timing, or reacting to market “noise.” Such temptations multiply during downturns, as investors looking to protect their portfolios seek quick fixes.

2. Fixating on losses

Market downturns are normal, and most investors will endure many of them. Unless you sell, the number of shares you own won’t fall during a downturn. In fact, the number will grow if you reinvest your funds’ income and capital gains distributions. And any market recovery should revive your portfolio too.

3. Overreacting or missing an opportunity

In times of falling asset prices, some investors overreact by selling riskier assets and moving to government securities or cash equivalents. But it’s a mistake to sell risky assets amid market volatility in the belief that you’ll know when to move your money back to those assets.

While past returns are not an indicator of future performance, they do give a fairly good indication of the differences in returns between different types of assets.

Shares are renowned for being more volatile than other asset classes, however they have typically delivered the best returns over longer-term periods.

Over the last decade, for example, the U.S. stock market has delivered a total return of more than 500 per cent. The Australian stock market has returned more than 180 per cent.

By contrast, record low interest rates have seen the annualised return from cash sit at 1.9 per cent. That’s translated into a total cash return over the last 10 years of 21 per cent (including compound interest returns).

Cash has definitely not been the best place to be, especially for retirees relying on income generation.

Consider hiring a financial coach

If you’re really not sure about what to do now, or your overall financial direction, you could consider consulting a financial adviser.

You can liken a financial adviser to a personal financial coach, who can help you to make informed decisions throughout your investment journey.

The benefits of engaging with an experienced financial adviser are many.

Importantly, an adviser can provide you with a roadmap to help you reach your long-term investment objectives.

That roadmap should factor in your overall appetite for taking on investment risk, including times of greater market volatility.

Do your homework

Financial advisers don’t just pick shares or recommend investments for you. They carefully analyse your personal circumstances and assess the market environment to develop a personal investment strategy.

Before you meet with a financial adviser for the first time it’s useful to have answers to the following questions:

  • What are my goals, objectives, and reasons for investing?
  • Does my investment strategy cater for both my short and long-term financial needs?
  • What roadblocks could get in the way?
  • What are the types of investments that will help me meet those needs based on my tolerance for risk?

Your needs, goals, and investment time frame change over time. So, too, does the market.

One of the ways your financial adviser can add value to your investment plan is by monitoring and periodically rebalancing the asset mix of your portfolio.

Together with your financial adviser, you can review your investment plan to make sure it stays on track to meet your short- and long-term investment goals.

 

Tony Kaye
15 Feb, 2022
vanguard.com.au

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