23 March 2022

Managing volatility

The world is changing yet again. The last few years have been a dream run for investors in shares and property with the occasional blip, and it’s been a nightmare for those who haven’t dared to stray beyond bank deposits, despite record low interest rates.

Now that unemployment rates have dropped and company profitability and economic growth have stabilised, the threat to world economies is not recession but inflation. It’s time to take the foot off the accelerator and put the brakes on. That means tighter monetary policy and higher interest rates. Alongside this, the world political situation has changed and presents risks that could interfere with global economic growth. We are entering a new phase with increased market volatility and uncertainty.

Let’s be clear on a few basics.

Volatility is the reason shares provide higher rates of return than bank deposits. It is nothing to be afraid of; it just needs to be managed. There are two main principles for managing volatility. The first principle is that your investment in shares must be diversified to reduce risk. The second principle is to match your investment strategy to your investment time frame. When investors lose money by investing in shares, it is because one of these investment principles has been violated.

The problem is many investors haven’t thought through what their investment time frame is. For most retirees, the plan should be to spend your funds gradually throughout retirement. Given that the average 65-year-old lives to around 90, this means you will continue to invest for many years after the day you retire.

For investors with a long time frame, short term volatility is nothing to worry about. Good fund managers will find opportunities to buy shares cheaply during a market downturn. The best returns are made by buying at a low price and selling at a high price. Inexperienced or nervous investors do the opposite; they buy near the peak when everything looks good, then panic and sell when the market drops.

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In times of volatility, always review your investment goals and investment time frame. If they haven’t changed, then you shouldn’t need to change your investment strategy, unless it was flawed to begin with. Make sure you have access to funds in stable investments such as bank deposits to cover your short term spending, so that you can ride out the changes in volatile investments.

During volatile times, novice investors often ask if it is a good idea to pull money out of investments before they fall in value and reinvest when the market recovers. The answer to that question is a resounding no! It is only ever possible to know when a market has either bottomed out or peaked with the benefit of hindsight, and by then it is too late to take advantage of the turning point. Research has proven time and time again that it is better to ride out market changes than to try and time the market.

So stick with your investment strategy and relax with the confidence that comes from understanding that volatility is what creates investment return.

Photo of Liz Koh
Written by:

Liz Koh

Liz Koh is a money expert who specialises in retirement planning. The advice given here is general and does not constitute specific advice to any person.

How Lifetime Manages Volatility and Capital

Amongst a number of considered and helpful points, Liz calls out how managing volatility is fundamental to protecting capital and delivering investment returns. Liz’s also talks to the difficulty of managing capital gradually through retirement.

This is what we do at Lifetime. In the Lifetime Retirement Income Fund we actively manage both volatility and capital to provide a regular income that will last a life time in retirement.

Liz points out poor volatility management can produce unnecessary losses and lost opportunities. In our Fund we have set a target return and a target level of volatility we will accept in order to generate the return. This is currently a volatility of between 5 – 10% with a target of 7.5%. If we expect volatility to fall our side of our limits we will move growth assets to cash to protect capital. We don’t expect to do these very often for the reasons Liz highlights albeit we have currently increased cash exposure as the world situation has meant we are now outside of volatility tolerances.

To manage capital through a retirement lifetime we calculate a unique annuity factor for all investors in the Fund. The annuity factor considers capital, age, gender, tax rates, inflation, expected investment returns and personal income requirements. The annuity factor tells us how much income an investor can receive each fortnight to ensure the income can continue to be paid to a set time in the future early 90’s, mid 90’s and late 90’s. We then review the factor every year to make sure the income levels remain on track to last a lifetime.

Photo of Ralph Stewart
Written by:

Ralph Stewart

Ralph Stewart is the Founder and Managing Director of the Lifetime Asset Management, managers of the Lifetime Retirement Income Fund.

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