What happens to your investment savings when a market crashes? And what strategies should you use?
The last month has witnessed a financial shake up not seen since 2008. Capital has evaporated from financial markets including Pension Funds, and the scary part is that there is no place for asset managers to hide or protect investments. With the media reporting on market crashes, investors may want to move quickly to protect their money, especially retirement savings, but is that the best strategy?
What has happened?
In the last month the JSE (JHB Stock Exchange) has dropped due to investors’ concern about the economic impact of the Covid-19 virus. Investors are worried that companies will not be able to produce goods and services if their employees are unable to work and as such, they are selling assets that they feel will be most affected. At the time of writing this newsletter, the JSE All Share Index was near 45 000 points while month ago it was around 53 400 points. That is a drop of almost -16%. The JSE has shown a slight rally in the past couple of weeks but this does not mean that the worst may be over. In the UK the FTSE index is down nearly -18% over the last month, while the Dow Jones index in the USA is also down a similar amount. This global drop in markets has left asset managers scrambling to find pockets where they can invest clients savings. When markets crash investors typically flock to “safe” assets primarily in developed countries. SA, being an emerging market is on the receiving end of investment outflows.
Source: Moneyweb
What should we do? Should I move into a low risk/conservative portfolio?
If you are more than 5 years from retirement, you should hold your course and ride out the crash. Your investments follow a specific strategy, and to follow this strategy the asset managers have to adhere to the mandate of the fund. If you are in an aggressive fund (high exposure to asset classes like equity and property), the asset manager will be looking for investments that have the potential to produce returns over and above the returns delivered by a conservative fund (exposed to assets like bonds and cash), over a certain time period. If you sell your units when the market is down, all you are doing is making a paper loss real in Rand terms. If you sell out of an aggressive fund and buy into a conservative fund, you are selling out at a loss and buying into a fund that is not designed to give high long-term returns. The table below from A Wealth of Common Sense shows the returns in the USA after a market crash. The average cumulative return 5 years after the bottoming out of the market is 132.3%. If you had sold out at the bottom and put your money under the mattress you would not have seen any of these returns!
So, when will the returns bottom out? Unfortunately, we do not know. However, we do know that it will bottom out.
Source: A Wealth of Common Sense
Will markets turn around?
Yes, financial markets will rebound, as they have after every single market crash in history. Financial markets go through cycles and right now we are on a downward trajectory. Below is a graph showing the returns for asset classes in South Africa from 2000 until now. You can see how the STeFi Composite (orange line invested in low risk, cash investments) hovers consistently around the 10% mark while the high equity assets (maroon and turquoise lines) have returns ranging from -15% to 39%. This shows that markets do rebound, and that having to accept volatility is part of a high equity constructed portfolio. When the market crashes, you naturally feel the urge to move your money into a “safer” portfolio, this can be seen in the dip in 2002. If you had moved your savings into a money market fund at that stage, you would have missed out on the gains from 2003-2006. The gains far outweighed the losses. You need to make sure you are invested in the market when it turns around.
Source: Morningstar Direct and Graviton
Should I put my money into a savings account until markets rebound and then put my money back into an aggressive fund when markets recover?
There are two challenges with this, firstly, you will be converting a paper loss into a real loss and secondly, you will be trying to time the market. This is a skill that even the best asset managers in the world never master. You want to be in the market when it rallies rather than try to predict when it will do so. Below is a graph showing the impact of missing out on key performance days on the JSE over a 23-year period. If you had invested R100 000 in February 1997 in the JSE until February 2020 you would have received R 1 549 225.86. If you were not invested in the JSE for just the 5 best performing days, your R100 000 would be worth R1 110 326.20. That is a drop of nearly R439 000 for missing only 5 of the best performing days over a 23-year period. The secret is to make sure you are still invested when the market eventually rallies.
Source: Sanlam Glacier
We are witnessing a market crash caused by a Black Swan event – something unpredictable and unexpected with a global impact. The most important thing to do is ride out the downturn and not to panic. A solid investment plan is still a solid investment plan during these times. The impact on your retirement money and your investments, is emotional, but the data shows that making rash decisions now will negatively impact your investments’ ability to weather this downturn. Markets will recover at some point in the future, and when they do, history has shown that the upside will be greater than the losses experienced. The only factor we do not know yet is when.