Capital Market increases are permanent, declines are temporary

ISSUE: Volatility

I’ve said it before but it bears repeating. Volatility is not loss. Capital markets are volatile, that is the price you pay for greater return. Market declines capture attention, the media dines out on them emotionally. Market increases have always exceeded market declines, the media reports them statistically. Each is either reported as the next cataclysmic financial Armageddon (at times of market recession) or reported in isolation (market gains) in a way that the general public displays complete disinterest. The media very seldom provides education or balance and why should it. Its role is not to be the advisor. The issue arises when markets and media align. That’s when financial advisers earn their keep, because investors panic. Even the most informed and practical of people can be worn down by volatility fatigue and media mania.

RATIONALE

Many Kiwi Saver investors have not taken advice. The product was made available through their employment or their bank has proffered the product. In neither instance are the organisations providing the product, qualified or permitted by law to give advice. It is illegal for them to do so (to give advice when not qualified to do so) but they can still make the product available to the general public and banks in particular are adept at transferring a competitor’s product (which may have been managed and monitored by a qualified advisor) to one of their own via sales staff. Again, completely devoid of advice – upfront or ongoing. (For which their employment and remuneration is dependent). 

It’s a little like the food industry. As more and more people tip the scales in to obesity the country starts to ask questions. What’s in the food? What are the kids eating and drinking?  The media highlights the exceptions and we groan with embarrassment as we look at the gym induced beautiful people or we take cynical delight at someone who’s eating habits are vividly displayed. The food manufacturers and outlets are making a bundle, the ‘diet’ industry is explosive and gymnasiums of all types and sizes are attempting to arrest the decline through personal trainers.

Kiwi Saver manufacturers and retail outlets are in the same commercial arena. It’s a trillion dollar industry and money attracts. Product peddling, media attention, inappropriate levels of advice, inadequate knowledge and a bureaucratic watch dog tilting at wind mills.

The same occurred in NZ when our capital equity (share) market grew dramatically and became more publically available in the 80’s.  Share clubs abounded, everyone had a hot tip from a secret source. The ‘Marble Bar’ in Wellington famous for its ‘knowledgeable’ movers and shakers. People bought product. Back then it was direct equities (shares). Minimal or no due diligence and certainly no investment principle with which to select or reject. (A plan, diversification, goals, asset class selection, sector discussion, review process, risk and reward consideration, nothing.) Tax free gains, hearsay and a decent dose of misplaced euphoria preceded the crash of 1987.

I’m not in any way alluding to a similar outcome for Kiwi Saver investors. Even Kiwi Saver products sold by banks or other product sales people will have a greater degree of diversification and asset allocation than the equity sectors being promoted by stock brokers of the 1980’s.

But there is a naively optimistic similarity at one end of the spectrum (the aggressive investors) and a nervous nelly group at the opposite whose attention to online transparency is driving them to distraction as markets perform their normal cyclical gyrations.

The millions of investors in NZ and their employers direct their pay deductions in to various Kiwi Saver providers and the fund managers of those various providers allocate and diversify those investment dollars into four asset classes. Equities (shares in NZ or overseas companies), Property (commercial NZ/International), Bonds (NZ and overseas) and Cash (predominantly NZ). Each asset class has a mean (average) of performance. No asset class future performance return is guaranteed, but the greater the standard deviation (the more volatile) the greater the expected return. The lower the standard deviation (cash) the lower the fund return. The missing ingredient – certainty.

The closest any advisor (however qualified) can allude is historical mean reversion and historical performance. No one can predict with certainty – we must live with predictable uncertainty if we want or need greater return or we select a lesser return for lesser volatility.

RECOMMENDATION

People panic out of temporary declines and are then embarrassed when permanent advances continue. Where is the long term risk in an asset class (S&P500/Equities) which is trending 4x where it was 20 years ago and paying a dividend 3x what it was then or at a level 10x higher than it was 30 years ago and paying a dividend at 4x. People mistake cyclical declines in stock prices for the risk of permanent loss. Volatility is not loss.

P.S.

60 year olds are likely to live another 30 years. Stop listening to the safety first brigade trying to direct you in to conservative assets. Get to understand how asset classes perform, understand how recessions are limited in time (40 months is the average from peak to trough back up to peak – including the great depression and the GFC). Your greatest risk is running out of lifestyle because you will attempt to live off yield (interest), you have just as much need to grow capital as does a 30 year old accumulator pre-retirement. Retaining purchasing power over a 30 year retirement should be your true focus and only growth investments will maintain that necessity as costs escalate in critical areas for the ageing community. Over 100% in 25 years at 3% inflation and 200% in 25 years at 5% inflation. Conservative investments (term deposits and bonds) are not going to deliver.