Waiting for the storm to pass


26/05/2020 5:13:49 AM // Written by Tom Rogerson

Waiting for the storm to pass

Following on from our recent guide to Spring Cleaning your finances, over the coming weeks we will be expanding on the recommendations, where appropriate.
 
Our first tip was to “Do Nothing”. Expanding on this may at first seem impossible, doing nothing should need no further explanation.
 
Specifically, we referred to doing nothing to your investment portfolio, as when we experience significant market volatility, this is a common knee jerk reaction; listen to the noise and take some (likely harmful in the long term) action within your investment holdings. However, if you’ve taken the time to build a low-cost, well diversified portfolio with a qualified financial planner, you should be sitting on your hands.

“How long are we going to be waiting for?”

Selling equities, and thus turning minus signs on your statement into cash losses, is the cardinal sin at times like these. History tells us that markets always recover, but you may be asking “How long will the recovery take?”. A very sensible question which the below figure hopefully helps us to answer.
 
The graph looks at the top 10 largest falls across different regions (Europe, Asia-Pacific ex-Japan, Emerging and World) and for three major equity markets (US, UK, Japan) and then shows the number of years taken to recover back to the previous high, in before-inflation terms[1]. There are some overlaps in the data, (e.g. the US is a material part of the World), but some valuable insights can be gleaned: whilst some market falls can take a decade or so, the majority have recovered in 5-6 years.  It is also worth explicitly pointing out Japan; from the market high in 1989 it took 27 years to reach the same level again (in GBP terms). This shows us two things; nothing is guaranteed, investing in equities is always a risk in which the outcome is uncertain, but secondly; holding a widely diversified portfolio can help mitigate some of that risk.

 

[1] MSCI World NR, IA SBBI US Large Stock TR, MSCI United Kingdom NR from Jan-72; MSCI Japan NR, MSCI Emerging Market GR, MSCI Europe NR, MSCI AC Asia Ex Japan GR from Jan-1988.

For most of you, the reason for investing your hard-earned cash is to cultivate a large enough fund that will provide you with an income, either now or at some point in the future. Your retirement or, shall we say, “later life” income needs to cover your basic needs and hopefully be able to sustain a few nice holidays a year. How much of the income comes from your investment portfolio will be unique to each individual’s circumstances; some may have company pension schemes, state pensions, and perhaps income other sources such as rental property; others may expect to rely exclusively upon their stocks and shares.
 
When markets are growing (as they have been overall since the Global Financial Crisis), there may be times where your portfolio value could grow year on year even after taking your income. Part of your withdrawals will be accumulated yield (either dividends from the companies you own or coupons from the bonds you own), and capital growth will make up the shortfall. However, when markets fall and uncertainty creeps in, especially reading about dividend cuts and stocks being down as we have seen in quarter 1 this year, it can be mentally challenging to leave equities alone and sell some of your defensive assets (cash or bonds) for income.
 
What is evident from the graph – except perhaps for a portfolio invested 100% in Japan – is that historic market falls all sit well within most clients’ investment horizons. Even investors in their 80s should be planning on an investment timeframe of at least 20 years (today an 80-year-old woman has a 1-in-10 chance of reaching 98[1]).

“What split of equities and bonds should I hold?”

The strategy outlined above assumes you hold some defensive assets, and therefore raises the question of how much an investor should allocate to cash and high quality fixed income. For those to whom certainty of income is critical this could be significantly higher than those to whom it is less critical. Logically, it should be the equivalent of anywhere from 5 to 13 years of expenses; sufficient to ensure that they can sit out any market fall relatively comfortably, without having to sell down equity positions.
 
It will also depend on other factors such as their need to take risk, their risk profile, and their financial capacity for loss, all of which should be discussed in detail as part of the ongoing financial planning process and is the topic of discussion for our next article.
 
Waiting is not so bad if you know the storm will eventually pass – just don’t forget your umbrella, it’s typhoon season.
 
 
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