Current markets can be a scary place
With two months to go before the year comes to a screeching halt, the current downward movement in markets has led to investors’ emotions ranging from concern to outright anxiety.
The markets have declined as follows:
S&P 500 year-to-date – 0.1% (down 9.3% on its high)
MSCI year-to-date – 3.3% (down 6.9% in October)
JSE Alsi year-to-date -12% (down 8.5% in October)
During these uncertain times, you have most likely been asking yourself one or more of the following questions:
Should I not be moving my funds from equities to cash?
Will I be able to retire?
Should I freeze/stop my contributions to my retirement/savings?
Market drop = Sale
Declining markets often result in investors reacting to the short-term negativity by selling equities, which in turn causes markets to spiral downwards even further. On the positive side of declining markets, the price of shares is really low. We love shopping when goods are on sale and can be picked up at a bargain, but it’s peculiar how our instinct responds in quite the opposite way when it comes to our investments. When markets fall, we want to sell because we fear that the market may drop further.
Paper losses versus real losses
Keep in mind that the decline in your investment is a paper loss. The value of your investment has declined. If the market recovers and the value of your investment increases to previous values, you have not lost anything. If you sell your equities to obtain cash, you convert the paper loss into a real loss and then you do not take part in the recovery. This implies that you have made a permanent loss on capital.
Another point to consider is that if you’re invested in unit trust funds, the funds distribute dividends and interest on a quarterly or bi-annual basis. These distributions are used to buy additional units in the fund and when the markets are down this means your distributions are buying more units.
Interest and tax
Many investors who switch out of equities to cash (money markets, fixed deposits etc.) often forget the effect of tax on the interest returns. If you’re paying tax at 40% and earning interest at 7%, your after-tax return is 4.2% (assuming that you’ve already utilised the annual tax-free portion of R23 800). This after-tax return is close to or below inflation, which means you may be losing the buying power of your capital (after-tax growth below inflation).
Below is a graph of research done by Sanlam Glacier, which shows the effect of not staying invested. Seasoned investment professionals cannot get market timing right on a consistent basis. Therefore, it makes sense to take the safe route and merely stay invested through the troughs and peaks.