Keeping your head as the markets fluctuate

AMP Chief Economist Shane Oliver looks at recent market volatility

We recently had the worst day on the Australian sharemarket for two years. What accounts for the ups and downs on investment markets?

Markets are always subject to volatility because investors are never quite sure how the future will pan out. So whether it’s Greece, interest rates or Chinese demand, you tend to see share prices falling whenever there’s a bout of uncertainty.

There are a few specific reasons for the recent turbulence.

  • Rising bond yields. Earlier this year government bond yields were collapsing due to worries about deflation. Those fears are now receding as the oil price has stabilised and moved higher, and European growth looks a little stronger. So bond yields have gone up, particularly in Europe on confidence that we will avoid deflation. And as bond yields rise, it sometimes puts pressure on the sharemarket because it makes shares look a little less attractive.
  • Sharemarket corrections. The back-up in bond yields has also affected global sharemarkets—some of which like European, Japanese and Chinese shares were vulnerable after strong gains. This in turn also affected the Australian sharemarket.
  • Our banks. In Australia we have a lot of high dividend-paying shares like the banks and they are particularly vulnerable whenever bond yields rise—particularly in light of mixed earnings and speculation the Reserve Bank might be nearing the end of its rate cutting cycle.

The falls over the past couple of weeks add up to about 6% from top to bottom. But most years we see overall corrections of around 10% following market gains. So what we’ve seen recently isn’t particularly unusual. Shares generally provide higher returns over the long term but the trade-off is higher volatility.

Should investors react to market volatility by changing their investment strategy and pulling their money out of shares?

The problem is that it’s very hard to try and time the market, particularly if you don’t have a process to help you do that. By the time you get out, it’s often after the market’s fallen and you don’t end up getting back in again until the market has gone all the way back up again. So you’re probably better off investing for the longer term.

Also, roughly half the return from shares comes in the form of dividends. And they haven’t changed—in fact, dividends are trending higher over time.

So a better approach could be to sit tight, accept that volatility is part and parcel of investing in shares and stick to a longer term approach.

What does a market correction mean for people’s super savings, particularly if they are worried about retiring at the wrong time?

How you respond will depend on a number of personal factors.

  1. Your balance. If you have a relatively high super balance and there’s a dip in the market as you approach retirement, it’s probably not going to have a huge impact on your quality of life. But if you have a relatively modest super balance, a dip just before you retire could have a bigger impact.
  2. Your plans for retirement. A market downturn could affect you more if you’re planning to draw down on your super savings a lot in the early years.
  3. Your tolerance to risk. When you’re retired and not receiving an income, it can be harder to deal with market ups and downs that affect your balance.
  4. Your life expectancy. In the past, it may have made sense to ‘de-risk’ your portfolio completely before you retired at 65 or so because you may only have needed your money to last for 10 years or so. But these days we’re living longer healthier lives. So you need to make sure your savings last for 25 years or more. If you focus too much on the risk of a correction affecting your wealth early in retirement and not enough on ‘longevity risk’, you could end up with a portfolio that’s too conservative and doesn’t last you through retirement.

It all depends on your individual circumstances so the best thing to do is to seek advice. You can find an experienced financial adviser who specialises in helping people like you here.

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© AMP Life Limited. This provides general information and hasn’t taken your circumstances into account. It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, AMP does not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, AMP does not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person.