Volatility is a natural function of markets, writes Ashley Gardyne. Photo / AP
Volatility is a natural function of markets, writes Ashley Gardyne. Photo / AP
OPINION:
The new year has already been far more volatile than 2021. Market turbulence can lead to a spike in investor anxiety, but it can also result in opportunities. In markets, stomaching some volatility is one of the costs of achieving better long--term returns.
Less than a month into 2020we've already experienced a significant sell-off in many markets around the globe. Concerns regarding inflation, rising interest rates, and the prospect of central banks withdrawing quantitative easing this year have sent shockwaves through markets.
At one point last week, both the New Zealand and US markets were down more than 10 per cent from their peaks, while the tech-heavy Nasdaq Composite was down over 15 per cent.
In some more speculative parts of the market, the action has been even more abrupt. The ARK Innovation ETF, which comprises high growth 'story stocks' in hot areas like electric vehicles, genomics and fintech, at one stage was down 30 per cent this year – and massive a 58 per cent from its all-time highs.
Those tempted by Bitcoin are also suffering, with the cryptocurrency dropping nearly 50 per cent from its highs before staging a slight recovery this week.
This sort of market environment can cause a spike in investor concern – particularly for those that are newer to markets. However, it is always important to put market volatility in context and recognise the richer set of investment opportunities that are offered up in market corrections. Learning to embrace volatility can prove highly profitable over the long term.
Volatility is a natural function of markets, and is what creates opportunities for investors Over the long-term the share market has delivered great outcomes investors. The New Zealand share market has delivered a return of 9.9 per cent per annum since the NZX 50 Gross Index was created in early 2001.
Over the last 100 years the US S&P 500 Index has delivered a return of 9.6 per cent per annum including dividends. Over the long term we would still expect the share market to deliver good returns – particularly relative to those on offer at the bank.
But markets don't go up in a straight line and there are often hiccups along the way. You should expect a 5 per cent fall in markets roughly every 9 months, a 10-19 per cent correction every 24 months, and a 20 percent-plus decline (a bear market) about once every seven years. (I've used the US share market here because there is better long-term data available).
A longer time frame helps dampen volatility, and focus investors on the real prize
Since 1990, the US S&P 500 Index has delivered and average return to investors of 10.4 per cent per annum. But this performance resulted from many years when performance was higher than 10 per cent, a few years when performance was between 0 per cent and 10 per cent, and a handful of years when share markets declined.
More importantly, there are very few years when the market hasn't suffered a 5 per cent-plus decline. There are also plenty of times when markets have suffered a 10 per cent, or even 20 per cent-plus decline.
Share markets aren't often smooth sailing like they were in 2021. But despite the bumps along the way, the market has still delivered great returns over this period. The cost of the higher returns available in equity markets is having to stomach some volatility along the way.
If you have the temperament for it, the payoff is significant. $10,000 invested in the US market back in 1990 would now be worth over $260,000.
A longer time frame helps dampen volatility, and focus investors on the real prize There is another powerful way to put share market volatility in context. Focusing on one year returns in markets, which are subject to the vagaries of human behaviour, isn't overly helpful.
Share prices get divorced from reality significantly over short periods of time. Over the longer term however, they tend to follow the underlying economic fundamentals of the companies you invest in.
Most investors in the share market also have an investment time frame much longer than a year. The average KiwiSaver investor is in their mid-forties and has another 20 years before they need to access their funds. Over longer periods, the risk of a fall in the value of your investment is much lower than it is over a one-year period.
If you only had a one-year time frame, you would have gained 47 per cent if you happened to invest in the best year, but you would have lost a frightening 39 per cent if you invested in the worst year.
With a five-year holding period, the worst annual return you would have received (if you got unlucky and chose the worst five-year period) would have been -3 per cent per annum. You would have made 28 per cent per annum if you invested in the best five-year period.
However, if you had the 20-year time horizon of many investors, the worst return you would have received if unlucky would have been 6 per cent per annum. Not a loss – a 6 per cent return – which would turn $10,000 into $30,000 over 20 years (in the worst-case scenario).
In a world focused on short term gains, this idea of 'time diversification' doesn't get enough attention, but it is a helpful way for investors to get comfortable with adopting a long-term investing orientation.
None of this is to say that there won't be more volatility in the days and weeks to come. No one knows how inflation will trend as we progress through the year, how central banks will respond, or whether Russia will invade Ukraine.
But one thing is for sure, we have faced similar issues before, and investors that didn't panic, held the course, and used volatility to their advantage typically prospered.
Ashley Gardyne is chief investment officer of Fisher Funds
