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Keeping your cool in heated times.
Date: Wednesday, 26th March, 2008. Source: MLC/Garvan Financial Planning.
As an investor reading recent financial headlines, you could be forgiven for getting nervous about your investments.
While the recent volatility in markets has been unsettling for many, it’s important to recognise that volatility in sharemarkets is not unusual.
In fact, what has been more unusual is the apparent lack of volatility in markets for the past several years.
The local sharemarket has posted amazing returns for a longer period than many forecasters had expected and the recent drops have just been a minor correction.
Despite heavily documented falls in late January, sharemarkets were soon bouncing back. However further wobbles in the value of equities are expected throughout 2008.
So what caused the market to drop?
The current volatility is a result of the sub-prime mortgage crisis in the United States. The root cause of the volatility lay in some of the riskier securities traded in US fixed income markets.
Mortgage-backed securities, based on residential mortgages, have been around for a long time.
However, over the last few years, home lenders have been increasingly willing to lend money to ‘sub-prime’ borrowers, who may have either little in the way of a deposit, or reasonable credit history, or even ability to repay loans.
Increasingly, these kinds of mortgages have been packaged-up and sold to investors. When US interest rates rose, a number of these borrowers defaulted on their loans. This in turn depressed the prices of these mortgage-backed securities.
The fallout from these problems facing the US housing sector could cause wider problems for the US economy.
Along with this, the uncertainty over just who has exposure to sub-prime loans and in what size has made it harder for even high quality institutions to obtain funds from the money markets.
All of this has unsettled global share markets, and the Australian sharemarket has not been immune.
The sub-prime mortgage meltdown has caused some drops in share value. But, it’s important to remember that ups and downs in the sharemarket are normal and an expected part of market behaviour.
Over the past seven years, there have been a number of big events that shook the market – the war with Iraq in 2003, the US terrorist attacks in 2001 and the ‘Tech Wreck’ of 2000. All of these events caused share values to fall, but they climbed back up.
Any investor who is in for the long-run will experience low or negative returns at some stage or another. Luckily, markets generally bounce back and eventually return to or even surpass previous levels.
The time taken for the market to recover varies; it may take a few days, months or years. Knowing when the market will recover is not possible, so you need to be prepared to invest for the long-term.
Be a smart investor
While it is smart to reassess your investment strategy in line with changes in your circumstances, experience has shown that investors who stick to their investment strategy consistently achieve better returns in the long term.
If you have a well-diversified investment strategy and your circumstances, financial goals and appetite for risk have not changed, then nothing that has happened over the past few weeks should trigger any action at all.
Indeed, if you abandon your investment strategy as soon as the market rumbles, you might end up converting a paper loss into an actual loss. Selling at a time when stock values drop contradicts the golden investment rule of ‘buy low, sell high’.
There’s also a saying that in the darkest night it’s easiest to see the brightest star. That’s also true of investing. When sharemarkets are out of favour, savvy investors see the potential to buy while prices are low.
So depending on your circumstances and advice from your financial planner, low prices may represent an opportune time to invest.
If you’ve any doubt, talk to your adviser to make sure you are still on track.
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