Smart.Happy.Money 19: Making sense of volatile markets.
Over the last few weeks we have seen falls, small recoveries and more falls across investment markets. Watching the news, it is easy to begin feeling worried about what is going on. Back in February, during a similar period of volatility, I wrote a blog about what we do when panic sets in. You can find that blog here. However, I thought it might be a good idea to approach the subject again.
Markets are inherently volatile. While we would all like to see a perpetually rising market, they do not go up or down indefinitely. In fact, corrections are a very important part of how markets work. If we didn’t see corrections like this, we would face an enormous bubble the likes of which we saw 10 years ago during the GFC and we would all like to avoid that.
There a few factors at play in this current market climate. The most powerful is the current American President. No matter what you think of his politics, Donald Trump is a volatile president and markets don’t love that kind of uncertainty. Donald Trump claims there are problems trading with China. He is probably right, and beyond trade the US is trying to stop China becoming the new world power. However, tariffs are probably the worst way for him to deal with this issue. Let me lay out how this has worked.
Trump wants to make it more difficult for China to sell goods in the USA
He adds tariffs (which are taxes) on Chinese goods
Due to the addition of the tariff (tax) the price of the good goes up
The US people purchasing these goods pay the extra tax
Rising prices results in inflation
Then we have his decision to cut company tax and tax on wealthier individuals, here’s how that works.
Companies and wealthy individuals now have more cash flow
They spend this cash flow in the US economy creating extra demand for goods and services
More cash flowing through the US economy results in additional inflation
This most recent market volatility was triggered by the US Federal Reserve bank talking about rising interest rates to combat rising inflation. Donald Trump then complained about the idea of rising rates, even though he is almost entirely to blame.
One of the most important jobs that Reserve banks around the world do is to keep inflation under control, they do this by changing interest rates to put money in or take money out of the economy.
If inflation is on the rise, they must raise interest rates to take money out of the economy.
So, what do we do? How do we make sense of all this?
Well, it’s good to remember that there is nothing new under the sun. As individual as Donald Trump may be, the world has seen trade wars, volatile leaders and market volatility before. How did people get through it?
There are two ways to mitigate volatility as much as possible.
Firstly, time in the market. Below you will see a chart prepared by Vanguard investments on what has happened to different asset classes over the last 30 years. You will see the times of volatility and even downright crashes including the GFC which fade away when you look at them through a lens of long-term investing. Looking back from 2018, no asset class has lost money over the long term be it 30 years, 10 years or 5 years.
The second chart I would like you to look at shows the best and worst performing assets classes from 1989 to 2018. The main point I want you to take from this chart is that the best performing asset is not usually the same as the year before, every asset class has had its day and by trying to pick the winner you will miss out. What does all of this come to? Diversification. By diversifying portfolios, we are trying to minimise the risks in a portfolio.
So Ben, why not sell everything and hold cash when markets are falling?
Well, I’m glad you asked. Trying to pick times to buy and sell often means that you sell after a fall and miss a bounce. A great percentage of the returns generated over time in an investment portfolio are made during a very small number of days. If you miss these days attempting to time the market your outcome is very much reduced.
The chart below shows the example of investing from 1998 to 2017 in the S&P 500 (US Market). If you had bought the investments and forgotten about it for 20 years you would have made a healthy 7.2% per annum. By missing just the best 5 day gains during that 20 year period your return drops to 5.02% per annum and your profit almost halves. Miss more than that? Well you can see the chart!
No one can time the market successfully. Don't we wish we all could!
At BGN Financial Management, we develop long term portfolios that are well diversified. This means that hiccups like this current correction have minimal impact on the long term results our clients will see.
Times like these are uncomfortable, nobody likes to turn on the news and see the share market dropping, especially as the media love to use words like ‘bloodbath’ and ‘wipe-out’. However, by sticking to long term, well thought out plans we can ride out these times and see great results over the long term.
Like I said back in February, let’s all take a breath and have a great day.
Ben Graham-Nellor is an advisor, coach, blogger and speaker who has worked in the financial services industry for over 15 years.
BGN Financial Management Pty Ltd is a Corporate Authorised Representative 468796 of Professional Investment Services Pty Ltd AFSL 234951 ABN 11 074 608 558 www.centrepointalliance.com.au
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