The mass media leads us to believe that sharemarket pullbacks are a bad thing. It makes sense, shares go down and everyone loses right?
What if I told you that market pullbacks aren’t that bad? In fact what if I told you that some investors can actually benefit during times of market volatility.
Read on to find out how to make money in shares.
The Stock Market Over the Long Term
If we take a really long term view of the stock market (as represented by the index), we can see that over time the trend has been higher.
Here is the longest chart I could find dating back to 1789.
Of course there have been periods when markets (as represented by the index) haven’t done much.
The chart (below) from Ed Easterling at Crestmont Research shows that there are market cycles where prices don’t do much.
For example if you had of held an average index based portfolio between 1900 and 1920 you total return would have been -1%.
So the question remains, how do you make money in shares – particularly where the market seems to be lurching from profit to loss every other month.
It Depends on Two Factors
The answer is that it depends. To work out whether you are a winner or loser in a market pullback you need to consider two factors:
- How much do you have invested now?
- How much are you contributing?
Superannuation is a good example of this process in action.
Let’s take a look at the action of the ASX200 index since 1 January 2015.
We will use the ASX listed ETF STW to represent the price performance so far this calendar year – where the market is lurching around like a drunken sailor.
Below are the actual prices of STW.AX from the start of each month for the calendar year thus far.
If we invested each month, paying these prices we would probably be underway now. So we are all losers in this environment. Maybe – but let’s take a closer look first.
Consider how this price action could apply to a regular investment strategy. A good example of this in action is a superannuation fund.
Consider our guinea pig, we will call her Betty. Betty has an income of $95,000 and therefore her super contributions are 9.5% of this amount or $752 / month.
Super Contributions = $752 / month $752 in contributions / month, works out at $6,016 over the 8 months to 1 September
Super Contributions = $752 / month
$752 in contributions / month, works out at $6,016 over the 8 months to 1 September
Now, let’s consider Betty has different starting balances in her super fund, ranging from $500, to $1 million. How will her super balance fair for the calendar year thus far?
Let’s find out:
As you can see, when calculate the regular contributions and the market performance everyone example is in fact underwater ($6,016 was contributed and the best outcome is $5432.30).
But this is all relative because it depends on the starting balance and the amount you are contributing.
So the end result was that Betty actually came out ahead for the balance of $100,000 or less, while she lost for balances over $100,000. The reason for this is because her contributions as a percentage of her starting balance were much higher.
So the end result was that Betty actually came out ahead for the balance of $100,000 or less, while she lost for balances over $100,000.
The reason for this is because her contributions as a percentage of her starting balance were much higher.
Buying More Shares at Lower Prices
Market volatility and pullbacks are a good thing because if your starting balance is small enough your existing capital won’t suffer the full effects of the pullback and you will be buying more investments at lower prices.
So consider the value of the contributions vs your current super balance.
As you can see with balances up to $100,000 the regular contributions have a meaningful impact.
If we look back at the previous charts, even if the market is languishing now, eventually when it gets going again the investor who has been buying regularly at low prices will do very well.
After a return of -1% for the 20 year period from 1900 to 1920, the share market returned 244% in the 10 years from 1920 to 1930.
The Moral of the Story
In all situations, losses are damaging to your long term wealth. Saying that, there is a way to benefit during times of volatility.
To make money in shares you need to know:
- How much you have invested already;
- How much you are re-investing and how regularly.
If you have a large portfolio compared to the amount you are re-investing, you need to watch what you already have. Losses are damaging. You need to protect your existing investment capital.
If you have a small portfolio compared to the amount you are re-investing, you can be happy you are buying more shares at lower prices (share trading).
If history is any guide (it is the only guide we have), you will do well when things eventually take off again.
The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you.