Dentists must protect against the 1,000-day stock market storm. With the huge shock to our systems the pandemic delivered last year, it is hard to believe that the correction in global stock markets in the spring of 2020 only lasted 100 days.
Markets rebounded through the summer and into the winter, as you can see in Figure 1 (below). Could anyone have thought last April, with the S&P 500 minus 30%, that the MSCI world index (global equities) would be plus 15.9% by year end!
The speed of last spring’s recovery poses the question: “If a lockdown pandemic where we cannot go out and spend money doesn’t hurt stock markets, what will?” Well as sure as eggs are eggs something definitely will. We just don’t know when, why or how.
The problem we have is that with the ‘risk-free’ rate (interest rates and bond yields) at 0% or below we have very little alternative to the equity markets to invest in. And the way stock markets have performed of late, there is also a ‘fear of missing out (FOMO)’ attached to not investing.
Managing risk better
As a result of zero interest rates, either peoples’ attitude to risk or their investment expectations have to change. The historical model of inflation plus 3% as an investment return is much harder to achieve now than it was 10 or 15 years ago. Yet in many cases this hasn’t quite rung true yet with investors. Most people when asked what risk/return expectation they have would respond “low-risk, 3-5% per annum would be fine”. At the present time, 3-5% growth is not achievable with low risk – even 1% would be difficult. The trade-off investors have is to either increase their risk to achieve return or maintain their existing risk level and reduce return expectations.
The way we think about suitable portfolio design for investors also has to change. The client assessment at the moment is worked out on the basis of market volatility over time, i.e., are you willing to take or tolerate risk? Therefore, portfolio design is worked out on the basis of how comfortable you feel about volatility. It should be worked out on what average return you require over time rather than the amount of volatility you’re willing to live with.
One of the dangers of zero interest rates is that salesmen come along offering snake oil or silver bullets that don’t exist. They promise investors rates of return that are unrealistic attached to risk levels wholly inappropriate for that investor.
Be prepared for the downturn
Peak to trough downturns can be significant and can last a long time, generally much longer than we saw in 2020. A fall in markets lasting two to three years really tests the mettle of all investors. The crux of it is, if you don’t ride out the drawdown you crystallise the loss, making the downturn a cost to you rather than just an interim fall in wealth valuation. Avoid turning a ‘mark to market’ drop into an actual portfolio loss.
The market plunge in the spring of 2020 was the sharpest fall since 1987 but it was also the fastest recovery. With three-quarters of your portfolio invested in global equities, a 30% market drop will give you a 20% fall in your wealth in a 12-month period. It would be worse than that if markets fall by 50%, where an investor’s growth portfolio will fall by 30% or more. The focus should not be on the day-to-day moves but rather how long will I have to endure the slide before it comes back.
The 1,000-day downturn
As the market recovered so quickly, in barely 100 days, it has been suggested that the 2020 correction could lull people into a false sense of security. Investors should be prepared for a 1,000-day downturn. If you base your portfolio design on such a fall you are more likely to be able to ride out negative movements and so avoid turning negative valuations into actual losses. Having that attitude may also give you the opportunity to buy in at cheaper market prices, at the right times. For the regular monthly saver/investor, downturns give a great opportunity to buy into markets at lower prices, allowing them to reduce the average investment cost.
Plan ahead if you are taking income
If you are taking an income from your portfolio or your approved retirement fund (ARF), plan ahead so that you can withdraw funds over the next two to three years without overly disrupting the portfolio. If you can plan ahead then you can afford to take the extra risk. If you don’t then you are running the risk of having to crystallise losses at the worst time, which is the surest way to destroy capital.
Financial planning, portfolio management and asset allocation are the holy trinity of good investment management. Be prepared with your portfolio and you will manage it well.
FIGURE 1: Cumulative index performance 2005-2020.