Over more than three decades in financial planning, I have seen sharemarkets tumble on quite a few occasions. However I have also seen share values recover and rally to new highs following a market low – something that doesn’t attract the same level of media attention.
In fact, over the past century, the Australian sharemarket rose in value in 74 years, and fell in 26. So, statistically speaking, in any given year there is a greater likelihood shares will record a positive annual result rather than losses.
Nonetheless, research by our investment watchdog ASIC, found one in 10 Australian investors lost money they couldn't afford to lose in 2015. This doesn’t always reflect the failure of an investment but rather a failure to understand how investments work.
ASIC’s study also showed that only one in three Australians understand the concept of the ‘risk/return trade-off’, which states that higher returns go hand in hand with a greater risk of losing money. Almost 70 per cent of people have little or no idea about the concept at all.
If you have a direct investment in shares, it’s critical to accept that, yes, in some years your shares may fall in value. Selling those shares in a downturn will mean taking a loss – something that may be avoidable if you hold onto the stocks until markets recover.
Perhaps the bigger concern is that today’s low interest rate environment coupled with jittery sharemarkets, could some see investors turn to more complex or speculative investments in the pursuit of high returns.
That may be fine if you are confident you know what’s involved. Just be aware of the risk. Ask questions and understand the true nature of risk in any investment before you do anything.
To see how much you understand about investment risk, take the MoneySmart Investing challenge. Understanding how it all works doesn’t make it any more enjoyable to ride out market lows but it can bring a sense of perspective to the current sharemarket action.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.
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