The Power of Staying Invested: A COVID-19 Case Study
During times of heightened investment market volatility, it’s human nature to wonder if savings should be moved to so called “safe havens” like cash or term deposits (TDs). This is especially the case if we are nearing retirement, when the sudden fall in the value of your assets is particularly galling after years of careful money management.
In this environment, remembering your long-term goals and remaining disciplined is crucial. One thing to note is that the world has weathered many crises in the past: world wars, economic crises and deadly pandemics. Markets have eventually emerged stronger after these tumultuous periods.
Panic selling in response to a sudden or dramatic market downturn creates two problems. One, it crystallises paper losses – turning them into real capital losses. It also puts the investor on the sidelines, uninvested when markets recover and, in a COVID-19 world, probably stuck in cash or TDs where rates are near zero.
Most big downward moves in the market tend to be concentrated in relatively short periods. In the short-term markets can be volatile, however, over the long term, history has shown markets eventually recover and move on to reach new highs.
What has happened in 2020?
There have been several catalysts for the most recent volatility in the markets. After COVID-19 hit, several factors shattered investor confidence. As investors grew increasingly pessimistic about the impact of the virus, widespread concerns led to stock prices dropping sharply. However, as we have come to better understand the virus and once containment measures started proving effective, investor confidence began to grow and investment markets have, to date, made a partial recovery.
Holding your nerve
The diagram below tracks the theoretical journey of emotional investors during the COVID-19 market crash and subsequent recovery. It highlights a series of mental ‘biases’ even experienced investors are prone to – biases that can cost investors’ money.
These are investors who:
bought into the market in late January 2020 (Point A on the diagram) when the S&P ASX200 Index was around 6800;
sold out in late March 2020 (Point B on the diagram) when the Index was around 5000 to move to cash or TDs; and
then bought in again during June 2020 (Point C on the diagram) when the Index was around 5800,
This set of actions would have crystallised a loss of roughly 21% as at 21 July 2020 using the assumptions outlined at the end of the document. Compare this with an investor who held their nerve, didn’t sell assets and would have only suffered a paper loss of 9.5% across the same period using the same assumptions.
Some of the behavioural biases experienced at different points during the journey include:
Loss aversion – people “feel” losses more intensely than gains – and act accordingly.
Confirmation bias – humans tend to seek and find information that supports an existing view
Hindsight bias – we often convince ourselves we knew something would happen – after it happened.
We may not know how the markets will play out over the medium term. We do know that some investors retreated to defensive assets at the wrong time and are likely to have already missed some of the recovery. So those who stayed focussed on the long term have likely already avoided some of the perils of trying to time the markets.
What does the future look like under COVID19?
Even though the market has recovered significantly from the sharp sell-off in late February and March 2020, there is still uncertainty about the economic fallout from COVID19 over the short to medium term. It's unclear how long the pandemic and social distancing measures will last, how much unemployment will rise, or how much it will hurt the economy.
Although the investment climate is still quite uncertain, being aware of emotional biases and having a written financial plan which captures your purpose and personal goals is invaluable. When referred to during market instability, it can remind you that your journey is a marathon not a sprint. As the adage goes, it’s time in the market, not timing the market!
If you have any further questions, please feel free to contact us - we'd be happy to help
1. The reference to investment is in the S&P ASX200 Index (Index) and is not subject to any trading or management costs. 2. Proceeds from the sale of investments were invested in a 4-month term deposit paying 1% p.a. (March 2020) with no exit-fees incurred on the term deposit when reinvested into the equity index. 3. The Index gain from 5800 to 6156 was captured by the investor selling and re-entering the market. 4. The buy and hold investor’s calculation period began when the Index was at 6800 and ends at 6156.