John Collett August 01, 2012
Strategy ... rebalancing is more about managing risk than enhancing returns. Photo: Andrew Sheargold
There are ways to mitigate the effects of a volatile sharemarket.
Share investors are faced with a conundrum. There's the emotional tug that says switch out of shares and share-based managed funds and go into the safety of cash.
But after years of woeful returns, Australian shares are looking cheap, with the shares of many high-quality companies on dividend yields that are much higher than can be earned on fixed interest or cash. Telstra, for example, is on a cash dividend yield of about 8 per cent after franking credits, while the best-paying one-year term deposits are paying less than 5 per cent with no prospects of capital growth.
If interest rates move further down, those dividend yields on high-quality shares will look even more attractive.
Stabilisation of Europe's sovereign debt crisis is likely to be a precursor to any sustained turnaround on the Australian and global sharemarkets.
But with stabilisation still some way off, growth in the global economy will likely continue to be weak.
The situation in Europe may even get worse before it gets better.
But a senior research analyst at Morningstar, Julian Robertson, says those with share portfolios can take actions that will at least help mitigate the effects of a volatile sharemarket.
Investors should maintain a long-term approach. ''Attempting to time markets or react to their whims on the basis of sentiment is generally a poor strategy for maintaining and growing wealth,'' Robertson says.
Returns on the Australian sharemarket have been particularly volatile since the onset of the GFC, with sharp swings from month to month.
To underline the difficulty trying to time the market, Robertson examined the 100 months to November 30, 2011, and found that if $10,000 had been invested in the Australian sharemarket at the beginning of the period, the closing value would have been $13,195, or a gain of 32 per cent. However, if the returns of the 10 best months are excluded, the closing value would be $7525, or a loss of 25 per cent.
Time in the market trumps trying to time the market.
''We believe that it is almost impossible to predict and profit from short-term market moves with any accuracy or consistency,'' he says.
Another strategy is ''dollar-cost averaging''. This is where investors drip-feed money into the market so they buy more shares for the same amount of money when the market is falling and fewer when the market is rising. That way investors are buying the shares at their average price over the long term, rather than running the risk of putting a big lump sum into the market only to have the market fall the next day.
This strategy could also be employed with a managed fund that invests in shares by having regular contributions going into the fund.
Another way of mitigating market volatility is to regularly rebalance the asset classes in an investment portfolio. Rebalancing is more about managing risk in a portfolio than enhancing returns, Robertson says. For example, if an investor has a split of 70 per cent ''growth'' investments such as shares and 30 per cent income investments such as bonds and cash, it's likely the income component would be much greater than 30 per cent now given the poor performance of shares.
That means the risk profile of the portfolio has changed over time to become more conservative when the investor's tolerance for risk is unchanged.
Investors could rebalance the portfolio back to 70/30 each year or two.
Strategies such as avoiding market timing, dollar-cost averaging and rebalancing will not eradicate the emotional tug markets have on investors but they will help manage the volatility of markets. Robertson says using a combination of these strategies, depending on individual circumstances, can help achieve long-term goals.