Ride the stock market rollercoaster

by Ben Power | 12 Dec 2012

Experts recommend that retirees stay on board the share market rollercoaster, even when things get tough.

Retirees have been on a wild stock market ride and when seeking stability, some began to wonder why they owned stocks. However, while stocks can be painful in the short term, in the long term they can generate stronger growth and higher returns than other assets like cash and bonds.

20-year plan

“People live a long time,” said Travis Morien, director of Australian Independent Financial Advisers, an independent fee-for-service financial planner. This means, that people are going to be retired for a longer period of time.

“These days it’s quite common for people to be retired for 20 years or more. What you’re seeing now is dramatic for someone who has a very short-term horizon. But if you have a longer-term horizon, bonds are not going to be the highest returning asset. There are very few periods where bonds have beaten stocks over the quite long term.”

A necessary risk?

The risk of the stock market compared to the relative safety of cash and bonds needs to be weighed against the risk of running out of savings. “Outliving your retirement savings is a very real risk for most Australian retirees,” said Andex Charts’ David Reid. “If a retiree can’t live off the interest they’d get from a term deposit or similar interest-bearing investment, they need to take on more risk in order to achieve a higher return.”

“The very good chance that an investment in shares will produce a negative return over the short term spooks many,” Reid said. “But it is the long-term numbers that matter when you’re attempting to fund a long retirement.”

The long view

While stocks are risky in the short term, over longer periods they usually outperform cash and bonds. Over 20-year periods since 1950, stock markets have returned around 12.9 per cent a year, against 8.8 per cent for bonds and cash. In the worst 20-year period for stocks, they matched the returns of cash and bonds. Not only do stocks produce long-term superior gains, they also have strong income-producing qualities. If you buy a $100,000 bond and get $4000, it’s going to stay the same each year. With stocks, you might get a $4000 dividend, and that dividend is going to increase each year. “Bonds don’t have a growth component,” Morien said, and the growth component helps stock investors stay ahead of inflation. 

Diversity

Many investors have invested in term deposits recently due to their high returns. But Michael Kloeckner, Director of Private Clients at Clime Asset Management, says that capital growth in stocks also makes it superior to cash. “Cash is not going to cut it,” he said. “Cash is going to be paying less in terms of deposit rates. Term deposit rates that are on offer now are reducing.”

So if stocks are good to hold for the long term, the question then becomes: how much should a retiree have in their portfolio?

“Asset allocation should be a budgeting exercise,” Morien said. “Short-term money should be invested conservatively. Money that’s needed for the longer term should be allocated to a more aggressive growth portfolio.” 

For retirees, Morien allocates the next five years of estimated spending very conservatively into low-risk cash and bond index investments. The estimated spending of the five to ten years after that are allocated to cash and bonds as well, plus some property trust index funds, Australian and international shares, and some emerging market shares.

For the money that won't be in the spending budget for over 10 years, Morien recommends higher-risk investment. “That's generally enough to weather most cyclical storms, and for that money I'm more comfortable recommending something growth oriented. That is, a portfolio containing the same types of assets as the medium term pot, but with less cash and bonds and more shares and property. The actual percentages vary in accordance with the client's risk profile,” he said.

Morien recommends index funds, which are usually low cost and track share market indices. He says they’re an inexpensive, low maintenance way to instant diversification. “They’re the optimal investment for nearly everybody,” he said. “Index funds also tend to be overweight in blue chips which gives them a pretty good franked dividend yield.”

Buy low and stay in

For those looking to pick stocks, value investors like Clime Asset Management seek to buy stocks below what they’re worth and have tended to outperform over the longer term.

Kloeckner says share market falls allow value investors to pick up bargains in stocks with high-dividend yields, strong profitability and management.

Ultimately, the key to riding out sharemarket volatility is to focus on the long-term potential of stocks.