Like most things in finance, a market downturn is impossible to predict with any certainty. When will it happen? How severe will it be? What will trigger it? No one really knows the answers, even when looking back in time as a guide. What we do know is that, while share markets have primarily been kind to investors in recent times, it’s inevitable that there will be a major market downturn at some point in the future, with the runway for that event likely shortening.
As an investor, you can’t control the markets, but what you can control is how you react when the market does turn. That way, you can ensure you are as prepared as possible for that eventuality.
Here are a few insights to help safeguard your investments as much as possible during a downturn.
Don’t try to predict it
The last major bear market was more than 10 years ago, when the Global Financial Crisis began. While history and statistics would suggest a bear market should have occurred at least once since then, any investor who sold down equities in anticipation of a downturn a few years ago, blindly following historical trends, would have missed out on some significant gains.
Part of the difficulty predicting market downturns is figuring out what might trigger them in the first place. History is again not particularly instructive in this regard. The various bear markets over the past five decades have had a range of triggers. There have been political triggers such as wars, shifts in investor psychology (like we saw in 2000 when the Internet stock bubble burst) and also economic shifts, like the unravelling of the sub-prime financial markets in the US in 2007-2009. The only constant among these events is that the trigger for these bear markets has only really been identifiable in hindsight.
Trying to time the market like this means that you not only have to ensure you sell at the right time at the market top – you also have to buy back in at the right time when the market bottoms. The likelihood of getting both of these moves right is very low and even professional portfolio managers rarely get this right on a consistent and repeatable basis.
Remember down markets are part of investing
While no one likes to see the value of their investments fall, stock market declines are a normal and relatively frequent occurrence. If you are a long-term investor, you will most likely experience several bear markets over your lifetime. Over the longer-term though, historical market returns prove that markets ultimately rise and provide solid long-term returns. Those investors who can ride out these market fluctuations are rewarded for their discipline and patience.
A 2014 study by JP Morgan showed that an investor who stayed fully invested in the S&P500 index from 1993 to 2013 would have earned an annualised return of 9.2% – even including the impact of the GFC. However, if that investor missed out on being invested during the 10 best market days during that period, their annualised returns would fall to just 6.1%. Missing the best 40 days – just over 1% of the total trading days – would have entirely eliminated any gains made over the period.
Try not to panic
Bear markets can be stressful and frightening. Share market declines can be dramatic and unexpected. At the time, it may seem like there is no end in sight, and the newspaper headlines will be littered with extreme predictions of doom and gloom. It’s sadly common for investors to fret through the early stages of a bear market, abandon their investment strategies and panic-sell at or near the bottom of the cycle. Generally, bear markets shouldn’t lead long-term investors to dramatically shift their asset allocations. Bear markets are typically short-lived (lasting an average of 18 months) and are followed by a rebound that occurs unexpectedly, often when the outlook appears most bleak. Most rebounds are also sharp, with markets typically gaining around 30% in the 12 months from the bear market low.
One of the best ways to protect your portfolio against periodic losses is to ensure your investments are divided between a mix of asset classes that reflects your appetite for risk. A suitably diversified portfolio of higher and lower risk assets will help buffer the impact of bear market cycles, which don’t last forever. Defensive assets such as bonds and cash yield tend to offer greater protection during a bear market but are unlikely to deliver rapid growth at other times. Higher-risk assets such as shares tend to drop more during a bear market, but are also the ones most likely to climb in value when markets inevitably recover. The right diversification among these asset classes will depend largely on factors such as your risk appetite and investment time horizon.
Control what you can
While you can’t control the markets, you can control (at least to a large extent) the amount you pay to invest and maintain your portfolios. Minimising fees and costs should be a critical focus of every investor’s strategy. The fees you incur while investing can have a dramatic impact on overall portfolio returns, particularly over the longer-term. This is because the lower the costs, the greater the proportion of an investment’s return that can flow to the investor and the larger the potential for that money to be reinvested and compound into the future. Over time, even small differences in fees and costs can add significant additional returns and can help generate a buffer against market declines.
David Blumenthal is the Director of Strategy and Analytics at Six Park (www.sixpark.com.au). He has more than 17 years’ experience across the finance, investment and asset management sectors, including at JP Morgan, NM Rothschild & Sons, and Credit Suisse.
Six Park launched in April 2016 with the goal of disrupting the Australian financial services industry. Six Park’s Investment Advisory Committee is made up of Six Park co-founder Brian Watson, formal Federal Finance Minister Lindsay Tanner and the founding General Manager of Australia’s Future Fund, Paul Costello. This advisory committee is active in overseeing Six Park’s investment strategy.