No one should doubt the power of market corrections to destroy wealth. These are weekly bar charts showing a 4 month market decline. The XJO has retreated from 6000 highs to a sub-5000 level and is approaching levels not seen since mid-2013. This is a 16.7% fall.
The XJO Accumulation Index (XJOA) has fallen almost as far, from 528 to 447. Accumulation indices include the compounding benefit of dividend income, and thus the ability for income to offset negative growth. It is 15.3% lower in four months.
Prime Minister Tony Abbott today reassured investors after yesterday’s global market falls that this was just a correction and they should not worry. Many investors assume that corrections are buying opportunities, and that they need only wait for the tide to turn.
It is true that retracements of 10-15% are not uncommon, but market crashes with 30-40% falls, such as the world experienced in 1987 and 2008, occur much less often.
But even these less serious occurrences hurt those in retirement, and those saving for it. They erode returns, and destroy confidence. Unfortunately it is impossible to know in advance how much the market will fall, and how long it will take to recover. It all depends on market sentiment, economic factors, the amount of corporate gearing, government interventions etc. Remember that after years of negative returns, the market often out-performs, compensating to some extent for the times of hardship.
If in doubt about current events, readers should consult their financial advisers. However as a consumer who has survived two global financial crises I offer a few observations of my own.
- Every investor should have an investment plan, and should have worked out in advance how to manage corrections.
- In building a portfolio set yourself investment standards, especially if you have speculative stocks. Stick to your rules.
- Do not presume that the market will react as you may think it will. Commonly bad news dribbles out from day-to-day, but may gather momentum with time to become a flood.
- Monitor market fluctuations carefully. For me the best guide to decision-making is to be guided by the points of market inflection. By this I mean noting whether trend direction changes make fresh lows or highs.
- Remember that rallies in a falling market provide the best-selling opportunities.
- If it is likely that selling will be the best option (you can always buy again later) usually the sooner you act the better the price you will get. Do not delay making your decisions. If the stock is in a down-trend, it is never too late to sell.
- Ensure that you have enough cash in hand to avoid margin calls on margin loans, to take advantage of buying opportunities when they present, and of course on which to live.
- When it comes to buying again, do not preempt the market. Be doubly sure that the stock is rising.
This list is not exhaustive, but they are my guidelines.