Financial markets can be like finely tuned racehorses, poised to gallop ahead under ideal conditions but often highly reactive to unexpected events.
It’s often said that the markets love certainty. Investors feel more confident when economic conditions are stable and predictable.
But certainty in financial conditions is never a sure thing. Uncertainty is always just around the corner with the possibility of changes in interest rates, new laws or regulations, upheavals in overseas markets, a breakdown in Australia’s relationship with a major trading partner, and wars and political instability.
As a result, stability and predictability are most often fleeting with peaks and troughs in prices inevitable.
Look at the past few years. Between 2020 and 2022, we were dealing with the side effects of COVID-19 on the economy and markets. Since 2022, interest rate rises, increases in the cost of living and conflicts in Ukraine and the Middle East have caused further market volatility.
This year, global political stability may be affecting markets with almost 50 per cent of the world’s population due to head to the polls to choose new governments including the United States, India, Russia, South Korea and the European Union.i Interest rate movements in Australia and overseas are another focus.
In this dynamic environment, investors find themselves grappling with crucial decisions about how to safeguard and optimise their portfolios.
It could be useful to know that making hasty decisions, reacting quickly to the latest event, may not be the best move.
Consider the performance of various assets classes over 24 years. If you had invested $10,000 in a basket of Australian shares on 1 February 2000, for example, your portfolio would have been worth $67,717 at 31 January 2024, delivering a return of 8.3 per cent each year.ii The same amount invested in international shares over the period would have provided a 5.4 per cent annual return with your portfolio then at $35,373.
US investment advisers Dimensional have calculated the risk to a portfolio of being out of the market for even a short period.
An investment of US$1,000 in 1998 of stocks that make up the Russell 3000 Index, a broad US stock benchmark in 1998, would have turned into U$6356 for the 25 years to 31 December 2022. But if you had decided to sell up during the best week, before later reinvesting, the value would have dropped to $5,304. Miss the three best months, which ended June 22, 2020, and the total return dwindles to $4,480.iii
In other words, reacting to events by quickly selling up can have an unwelcome effect on your portfolio.
Trying to time the market by identifying the best and worst days to buy and sell is almost impossible. Investing for the long-term in a well-diversified portfolio can better suit some investors.
Historically, long-term investors who have weathered short-term storms have been rewarded. Markets have shown they tend to recover over time, and a diversified portfolio allows investors to capture the upside when conditions improve.
And there’s a bonus. The compounding effect of returns over an extended period can significantly enhance the overall performance of a portfolio if they are reinvested.
Why diversify?
Different asset classes – such as shares, bonds and cash – perform differently at different times.
By diversifying investments across different asset classes, regions and companies, can work towards reducing the effect of a poorly performing asset on the overall portfolio, providing a buffer against volatility and lowering risk.
Appreciating the lessons learned from the past while also understanding that past performance may not predict future performance, is a helpful way of navigating the uncertainties of the global markets.
We can help you stay committed to a robust investment strategy, design a portfolio that meets your objectives and help navigate the complexities of the markets. Reach out to us to help you invest confidently.
Source: Vanguard Digital Index Chartiv
Source: Dimension Funds Advisorsiii
i The Ultimate Election Year: All the Elections Around the World in 2024 – Elections Around the World in 2024 | TIME
ii https://insights.vanguard.com.au/VolatilityIndexChart/ui/retail.html
iii What Happens When You Fail at Market Timing | Dimensional
iv Vanguard Index Volatility Charts