The last 6 months has seen historical rate hike moves, global inflation fears and the impending threat of recession that makes the financial downturn of COVID-19 and the war in Ukraine seem like a distant memory.
What felt like at the time in March 2020 to be an inevitable collapse of global economies and financial markets, was an initial steep drop, followed by a rally to December 2021 that exceeded everyone’s expectations to a gradual decline we find ourselves in over the past 9 months. We’ve been on a rollercoaster that could put the ‘Superman Escape’ ride at Movie World to shame.
So what can we do? We could panic sell down to cash and try to time the market to jump back in, but history shows that it is almost impossible to do this consistently over the long-term. I suggest a two-part strategy.
First, try to overcome your knee-jerk emotional response to volatile markets, then, redirect your attention to a disciplined and practical approach to investing if you are to avoid making mistakes in these uncertain times.
For some, this first part can often be the hardest. Humans are creatures of habit, and we feel comfortable with what we know and what we can control. Unfortunately, our default reaction to a crisis is not always in our best interest. To help break these “bad” habits, it’s prudent to initially become familiar with some common cognitive biases that we all have shared at some point on our investment journey.
- Loss Aversion bias helps explain why losses hurt more than gains are relished. It causes us to avoid risks and in the case of market volatility, can lead to us panic selling in the hopes of avoiding any further downturn.
- Anchoring bias is when you value certain pieces of information too much to the point that it can cloud your judgement, especially when it comes to timing the buying or selling of an investment. For example, you may be holding out to buy a property because you’ve “anchored” onto news of increasing interest rates.
In response to the above, I offer a practical strategy to help you overcome and ignore the “noise” in the form of dollar cost averaging.
Dollar Cost Averaging
Dollar cost averaging (DCA) is a disciplined investment strategy that suggests investing equal amounts of money at regular intervals, regardless of the price of the investment. At times you will be buying when the price is high, and at other times, when the price has fallen (low). The aim is to prevent you from making investment decisions based on your immediate emotional reaction to market volatility (“noise”).
To illustrate this, if you’d invested $10,000 into the Australian share market back in 2002, your initial investment would be worth around $50,000 at June 2022. To achieve this, all you would have needed to do was elect to reinvest your dividends consistently during this time (dollar cost averaging). Even better, if you had made a $250 investment into the market every month, your portfolio would have grown to $180,000. The additional $60,000 investment over 20 years, has produced an additional $130,000 more than if you had made no extra contributions (Vanguard, 2022). This further illustrates the magic of compounding investment returns.
You may be thinking that you’ve left it too late to start this investing approach, but fear not, if you’re an employee with a superanuation fund, chances are you’re undertaking this strategy indirectly already. Each month/quarter, your employer makes a contribution to your superannuation fund which is automatically invested, regardless of what the markets are doing at the time.
My suggestion is to action this same strategy yourself as a disciplined and practical solution to overcoming any investment paralysis you may be feeling in these trying times.
