Sticking with your investments when they are falling isn't easy. In trying times, it’s tempting to abandon your investment path. But until you sell, any losses are just on paper. If you do sell, you have effectively locked in your losses. When investing for the long term, staying the course can be a strategy to reach your investment goals.
Why global troubles are putting your investments under pressure
Our world is so interconnected that we feel the impact of events that happen on the other side of the world. Take the Russia–Ukraine conflict, for example.
With Russia being a major supplier of oil and gas1, and plans for Russian oil supplies to be phased out by many western countries, you may have noticed higher costs at the petrol pump. This flow on effect has increased costs for companies to supply us with goods from around the world, resulting in rising prices at the supermarket and elsewhere.
With higher petrol prices and other costs cutting into company profits, financial markets are volatile around the world, including Australia. This is because higher costs have reduced expectations for companies to grow their earnings in the short-term, which has caused financial markets to fall.
Markets tend to react to news and events that make the short-term outlook unclear. Although when markets recover, these periods of volatility can look relatively insignificant over the longer-term.
Why rising interest rates are causing short term pain
Inflation – or the cost of living – is rising around the world. To manage this, central banks like the Reserve Bank of Australia are increasing interest rates. In the short term, rising interest rates can cause negative returns for your fixed interest investments.
On the face of it, it seems odd that rising interest rates would cause negative returns for fixed interest investments. Yet when interest rates rise, the value of fixed interest investments can fall. So although the interest payments received from fixed interest investments is fixed, the value of the investment can rise and fall over the short term.
Rising interest rates can also make the environment more challenging for shares. Share markets react to the changes in interest rates because it can signal whether or not the economy is strong. Higher interest rates could also impact the company’s cost to do business, thus changing how investors value a company, which could have a negative impact on the company’s share price.
What locking in your losses can be mean
When your balance has fallen it’s tempting to retreat to stable investments that don't move up and down in value. You may be looking to hide from the current market storm and plan on getting back into your investments later when returns are looking better.
Until you actually sell your investment, any gains or losses are not locked in. Taking the risk of selling when returns are negative locks in losses. Historically, these downturns can look like blips, so staying invested could be a better option for your long term plans.
Here's an example
Sam and Chris each invested $100,000 in a growth investment fund in 2002.
Sam remains invested in the growth fund, staying with her investment strategy throughout the Global Financial Crisis of 2008 and subsequent market recovery.
In contrast, Chris becomes increasingly nervous during the Global Financial Crisis when he sees his investment balance fall. So he sells his growth investment option near what turns out to be the low point of the decline. He locks in his losses and invests in cash instead.
Now, wary of the higher risk of share market investing, he keeps his funds in cash as a safer option for 12 months until he’s confident markets are recovering. In the meantime, markets pick up again and the growth fund’s performance started to improve.
But because Chris wasn't invested, he missed out on the recovery and his return on cash was lower than that of the fund. Chris would have been better off if he had stayed with his initial investment.
Because Chris locked in his losses, his balance in 2022 is $75,645 less than Sam’s.
The above example is for illustrative purposes only and does not take into account your individual objectives, financial situation, needs or tax circumstances.
Source: Colonial First State. Date from 30 April 2002 to 30 April 2022. Data derived from performance of FirstChoice Wholesale Growth Fund and CFS Wholesale Strategic Cash Fund. This case study depicts one of many potential scenarios and is an illustrative example based on a specific 12-month timeframe within the calculation assumptions. Other outcomes are possible and may vary depending on the timing and duration of an investor’s switches between the growth option and cash. Past performance is no indication of future performance.
This is not to say you should not sell. The level of risk you are willing to take largely depends on your personal circumstances, appetite for risk and investment timeframe. The shorter the timeframe for investing, the more at risk you are to short-term fluctuations. Investing over a longer period means that your investments will probably have time to ride out short-term ups and downs.
It’s normal for investment markets to rise and fall over time. Market downturns and periods of volatility are a normal, yet unpredictable, functions of markets. But for investors, a market pullback can be filled with fear and uncertainty. It’s natural to want to protect your portfolio in or after a market decline by switching into cash. History shows that markets tend to be resilient, and when markets recover, these downturns can look like blips over the longer term. That’s why it can be better to remain focused on your long term financial goals.
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If you’re concerned about whether you should make changes to your investments, we recommend connecting with your financial adviser to review your investment goals, identify any potential opportunities, and make changes if necessary.
If you don't have an adviser, you can find an adviser here or call us with any general queries on 13 13 36, Monday to Friday, 8:30am to 6pm Sydney time (+612 8397 1100 from outside of Australia).
1 Reuters, What would a U.S. ban on Russian oil mean for the world?, 8 March 2022, accessed 24 May 2022.
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Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 (AIL) is the trustee of the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557 and issuer of FirstChoice range of super and pension products. Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL) is the responsible entity and issuer of products made available under FirstChoice Investments and FirstChoice Wholesale Investments.Information on this webpage is provided by AIL and CFSIL. It may include general advice but does not consider your individual objectives, financial situation, needs or tax circumstances. You can find the target market determinations (TMD) for our financial products at www.cfs.com.au/tmd, which include a description of who a financial product might suit. You should read the relevant Product Disclosure Statement (PDS) and Financial Services Guide (FSG) carefully, assess whether the information is appropriate for you, and consider talking to a financial adviser before making an investment decision. You can get the PDS and FSG at www.cfs.com.au or by calling us on 13 13 36.