The sharp falls on global financial markets over recent weeks – the biggest declines we’ve seen since the Global Financial Crisis more than a decade ago – have many investors understandably very concerned.
Fuelled by the outbreak of COVID-19, otherwise known as the coronavirus, and more recently by huge declines in oil prices, share markets in Australia and elsewhere have effectively erased all of the spectacular 20%-plus gains they achieved in 2019.
The wild ride isn’t over yet either, with expectations the fallout from these recent events could continue indefinitely, as governments and businesses around the world grapple with markets’ volatility and the flow-on economic shockwaves.
This chart shows various share classes and how they have performed over time, to 31 January, 2020. Key events are also highlighted. Source: Vanguard
Coronavirus and the share market: Keep calm and stay the course
In uncertain times, investors often panic and make knee-jerk decisions in an attempt to limit their losses.
Yet history suggests the best strategy for long-term investors is to do the exact opposite. Rather than getting caught up in daily market movements, even when they are extreme, generally the most sensible approach is to do nothing at all.
The best way to illustrate this is to look at the performance of investment asset classes over a much longer period of time. And doing that shows investors, by and large, have consistently achieved good returns by simply sticking to a long-term investment strategy.
This year happens to mark two decades since the turn of the century, so there’s a full 20 years of market returns to analyse.
As one would expect, returns across different asset classes over the last 20 years have varied considerably. The 2007 to 2009 period in particular shows a sharp deterioration in asset values initially stemming from the 2007 US subprime property crisis that sparked the GFC.
After peaking in November 2007, the Australian share market plunged 54% over the 14 months to February 2009, before beginning a long-term recovery run.
Investment markets have experienced many bouts of volatility since then, driven by diverse events including natural disasters, Brexit, wars and recent worries around US-China trade tensions.
However, despite this, the US and Australian share markets reached record highs in February, before the onset of the latest unforeseen events.
Consider the long-term returns picture
Over the past 20 years (up to before the coronavirus outbreak), the Australian share market returned more than 8% a year on average, turning a hypothetical $10,000 investment made in January 2000 into just over $52,000 by the end of January this year. That’s a 390% total return, excluding any fees, expenses and taxes.
A $10,000 investment into international listed property over the same time frame would have returned around 10.2% per annum and be worth more than $70,000, using the same assumptions as above. That equates to a 580% total return.
Investors in any of the major asset classes would have done well over the past 20 years, and obviously those with investments across multiple asset classes would have achieved the smoothest returns.
But you didn’t need perfect vision 20 years ago to predict that total asset class returns would increase over time. It’s a basic rule of compounding that when investment returns are reinvested over a long period, the value of a portfolio will also increase.
You can replicate this same long-term pattern over other periods of time. Having a regular investment contributions strategy will increase returns, in the same way as compulsory and voluntary superannuation contributions add to members’ account balances in the accumulation phase.
The importance of diversification
Looking into the future, without a crystal ball, will likely show a cloudy short-term outlook with more bouts of heightened market volatility as the current global events play out.
But savvy investors, in addition to having a long-term plan and not getting distracted by “market noise”, typically would also be following another ‘golden rule’ – diversification.
Asset class returns will vary, as they always do, depending on different catalysts.
But, as can be seen on the index chart, spreading your money across a range of investments is the easiest way to help reduce your exposure to market risk.
This way you are not relying on the returns of a single asset class.
A few of the most common ways to diversify are:
- Include exposure to different asset classes, like shares, fixed interest and property.
- Hold a spread of investments within an asset class, like different countries, industries and companies.
- Invest in a number of funds managed by different fund managers. For example, consider blending active with index managers.
Of course, everyone’s situation is different, and the right mix of asset classes or investments for you will depend on your goals, time frame and tolerance for risk.
About Tony Kaye
Tony Kaye is Senior Personal Finance Writer at global funds management group Vanguard.
Cover image: JMiks (Shutterstock)