Market volatility is challenging. However, staying invested, keeping emotions in check, and focusing on long-term goals is the clearest path to wealth creation says Stephanie Whittaker. Informed Investor, p42 Issue 44
For even the most seasoned investors, market volatility can be unnerving. Recent market fluctuations – driven by US tariffs, inflation, and geopolitical instability – have once again tested the resolve of Kiwi investors. While all these changes make daily headlines, a fundamental truth remains: volatility isn’t a bug, it’s a feature of all financial markets.
Markets are inherently cyclical. Periods of expansion are usually followed by contraction, driven by economic data, interest rates, earnings surprises, and geopolitical developments. While it’s tempting to try respond tactically to each market movement, holding firm is often the price pf long-term gain.
Volatility: a byproduct of uncertainty
The current wave of volatility comes from many sources – President Trump’s changing tariffs, supply-chain issues, inflation and several global tensions such as the war in Ukraine and the war in Gaza. This has led to increased daily price swings, a hallmark of uncertain economic environments. However, these conditions, while distressing aren’t unprecedented.
History offers countless examples – wars, recessions, pandemics – when markets eventually rebounded afterwards, often stronger than before.
For example, the S&P 500 has returned over 9 per cent per annum (on average) since 2007, through the global financial crisis (GFC), Covid-19 pandemic and the 2022 inflation spike. Each of those crises may have felt like the end of the world at the time, but the markets recovered strongly each time.
Don’t confuse volatility with risk
Volatility often triggers a gut reaction: fear. But it’s important to distinguish between volatility – the temporary up-and-down movement of asset prices – and risk, which involves the permanent loss of capital.
Moving to cash or switching to a conservative fund during a downturn may feel safe, but it can mean you unnecessarily crystallise losses and miss out on the eventual recovery. In most circumstances we’d advise our clients against this.
As an example: even if your KiwiSaver account balance or managed fund balance is down, the number of units or shares you hold remains unchanged. What fluctuates is the market value of those units. Selling during a downturn converts a paper loss into a real one, while holding steady allows for the possibility of recovery and compounding returns.
Timing the market vs time in the market
Almost everyone feels the temptation to try to time the market by moving in and out based on short-term trends. Yet this strategy is notoriously difficult to execute successfully.
Analysis of the markets post the GFC and Covid-19 lockdowns has shown that the benefit of rebalancing your portfolio at the “perfect” time isn’t worth the risk of missing out on market recovery, compared to just holding on to equities. What’s more, as time goes on, the probability of picking that “perfect” time decreases.
Markets tend to recover quickly and unpredictably. Missing just a few of the best-performing days can significantly impact long-term returns. The good news is that staying the course doesn’t require special investment skills, just discipline!
During downturns, investors with long time frames may even consider increasing exposure to growth assets – buying into the market at depressed valuations can enhance returns when the cycle turns.
To help investors understand this concept, Generate created the eye-opening graph above. It shows that significant gains could have been made by those who invested more in Generate funds during the downturn that followed the Covid-19 lockdown in 2020.
Fund choice and the risks of switching
Within KiwiSaver, the right type of fund plays a key role. Aggressive and growth funds, with higher exposure to equities and international markets, are inherently more volatile, but offer higher return potential over the long run.
Conservative or defensive funds are designed more for capital preservation, so offer lower returns.
The graph clearly shows how switching to a more conservative fund meant the investor made significantly less over the long-term, than they would have if they’d simply stayed in their growth fund through the market sell-off and recovery.
For investors still 10 or more years away from withdrawing their balance, staying in a more aggressive fund through market dips could be more beneficial.
And while it may sound like a counterintuitive approach, buying more units at lower prices during downturns increases the potential for greater gains during the recovery – this is shown as Option 3 on the graph, which yields the highest returns over the long-term.
The track record of long-term investing speaks for itself.
As Warren Buffet put it so well: “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
KiwiSaver members and other long-term investors should draw confidence from history and focus on fundamentals: time, diversification, and strategic patience. Short-term underperformance is not a failure of the strategy; it’s simply a normal part of investing.