As wealth managers we are constantly monitoring the financial “news” media, and like our clients, we see regular “warnings” from financial “gurus” that there is a risk of a market decline of 20% or more.
There is always somebody offering an opinion on what might happen to the global economy and, consequently, share prices. And the financial media feeds off bad “news”. After all, it makes headlines in order to sell copy.
But it’s important to put these headlines into perspective and realise that the experts voicing these views are often simply putting forward opinions about what might happen to equity markets if events in the economic world go one way or another. More often than not they aren’t making predictions, they are simply stating what could happen.
And the thing about the financial markets is that short-term predictions are more often wrong than right, and trying to time the market on average produces worse returns than remaining invested.
The question is: “Where does this leave us as investors?”
The more relevant question to ask yourself is “How would a market setback of 20% or more affect my long-term financial plans?”
And one thing that is certain is that equity markets do experience bear markets (a correction of more than 20%) from time to time. So this is a question that should be addressed at the start of any long-term financial plan, and then reviewed regularly. That is a large part of our job as your wealth adviser.
If, for example, you’re at the stage of accumulating capital for your eventual retirement then you and your financial planner should have a plan in place that involves the purchase of investment assets that, with modest average returns over time, will provide you with sufficient capital at retirement to sustain your lifestyle.
It’s strange that in almost every purchasing decision we aren’t averse to buying when prices seem depressed. Take the purchase of real estate for example. We often talk about it being a “buyer’s market” when prices have dropped.
Unfortunately, it doesn’t seem intuitive to apply the same principle to financial assets such as equities, and clients always (naturally) need reassurance to carry on buying, rather than disinvesting, when markets have a setback.
However, if you’re in buying mode, as somebody accumulating assets for a retirement fund should be, then a market decline should be seen as an opportunity to buy more assets for your money. History being our guide, share prices always recover from a decline, so why wait for the recovery to start buying the same assets at a higher price?
Of course, for the person who is already drawing a pension from the equities they have accumulated during their working lives, then a market decline can be more of a problem. You really don’t want to be selling those equities at depressed prices for a sustained period of time.
The answer to this predicament is to not get into it in the first place. We regularly advise our clients to hold sufficient cash reserves to cover their living expenses for at least two years. This avoids the need to be regularly selling equities during a sustained decline in prices.
This does not by any means suggest that you should get out of equities completely, far from it. Investing in other assets such as fixed income bonds will not provide the inflation beating returns you will need to provide your retirement income in an inflationary world.
Remember that occasional stock market volatility is not your enemy in retirement, but the ongoing erosive effect of inflation over decades of retirement.
Fixed interest assets will not give you the long-term protection against inflation that you need. A portfolio of shares in the world’s greatest companies however has consistently provided rising dividend income along with increased capital value.
It’s worth noting that over the past 30 years the US Consumer Price Index approximately doubled. Over the same time the cash dividend of the S&P 500 increased almost five-fold. And over the same time the capital value of the S&P 500 has increased more than ten-fold.
The answer then is not to wonder whether the “expert” prediction of a market decline is accurate or not, but to ask yourself what affect it would have on you if it does happen. If you’re in accumulation mode, then it will be an opportunity. But if you’re in withdrawal mode you can avoid any adverse effect by planning ahead and holding sufficient cash reserves.
Planning ahead is straightforward whereas trying to predict short-term events is a black art!