Let’s be clear on a few basics. Volatility is the reason shares provide higher rates of return than bank deposits, writes Liz Koh.
Liz Koh is a money expert specialising in retirement planning. The advice given here is general and does not constitute specific advice to any person.
OPINION: The world is changing yet again. The last few years have been a dream run for investors in shares and property with the occasional blip and it’s been a nightmare for those who haven’t dared to stray beyond bank deposits, despite record low interest rates.
Now that unemployment rates have dropped and company profitability and economic growth have stabilised, the threat to world economies is not recession but inflation. It’s time to take the foot off the accelerator and put the brakes on. That means tighter monetary policy and higher interest rates. Alongside this the world political situation has changed and presents risks which could interfere with global economic growth. We are entering a new phase with increased market volatility and uncertainty.
What does this mean for investors? The good news is that higher interest rates will benefit those who prefer to keep a decent chunk of money in the bank. In the low interest rate environment, investors went hunting for higher returns in shares and property, however, increased volatility in these markets is likely to see a retreat back to bank deposits to some extent.
Term deposit investors need to bear in mind that their challenge is to keep ahead of inflation and tax. Higher inflation is likely to erode any benefit from higher interest rates. Bank deposits are best looked upon as a safe place to keep funds to cover short term spending. They will always struggle to provide an investment return sufficient to outpace inflation.
Volatility is something that long term investors have no choice but to live with. Seasoned investors have learned to use volatility to their advantage, while for nervous investors, there will be plenty of opportunity over the next two or three years to make bad investment choices that could bring about unnecessary loss.
Let’s be clear on a few basics. Volatility is the reason shares provide higher rates of return than bank deposits. It is nothing to be afraid of; it just needs to be managed.
There are two key principles for managing volatility. The first principle is, your investment in shares must be diversified to reduce risk. The second principle is, you must match your investment strategy to your investment time frame. When investors lose money by investing in shares it is because one of these investment principles has been violated.
The problem is, many investors haven’t thought through what their investment time frame is. For most retirees, the plan should be to spend your funds gradually over the course of retirement. Given that the average 65-year-old lives to around 90, this means you will continue to invest for many years after the day you retire.
For investors with a long time frame, short term volatility is nothing to worry about. Good fund managers will find opportunities to buy shares cheaply during a market downturn. The best returns are made by buying at a low price and selling at a high price. Inexperienced or nervous investors do the opposite; they buy near the peak when everything looks good, then panic and sell when the market drops.
In times of volatility, always review your investment goals and investment time frame. If they haven’t changed, then you shouldn’t need to change your investment strategy, unless it was flawed to begin with. Make sure you have access to funds in stable investments such as bank deposits to cover your short term spending, so you can ride out the changes in volatile investments.
Often during volatile times novice investors ask if it is a good idea to pull money out of investments before they fall in value and reinvest when the market recovers. The answer to that question is a resounding no! It is only ever possible to know when a market has either bottomed out or peaked with the benefit of hindsight, and by then it is too late to take advantage of the turning point. Research has proven time and time again that it is better to ride out market changes than to try and time the market.
So stick with your investment strategy and relax with the confidence that comes from understanding that volatility is what creates investment return.