December 15, 2018
Most of you will have noticed the sharemarket has fallen in recent months.
A bit over 10%. Nothing spectacular to be honest. But enough to make new investors nervous.
Will the market keep falling? What should we do?
There’s lots of questions and concerns. And that’s completely normal. It’s not nice to see your investment fall in value. I feel it too.
But if we learn some fundamental truths about investing and the markets, we can then handle any scary times much better. So today I’ll share how I think about market drops and give you a sensible approach to follow.
Firstly, let’s put the recent fall in context. The market, as measured by the S&P/ASX 200, is down from a high of 6,374. As I write this, it sits at 5,680.
That’s a fall of 11%. Not great. But not unexpected.
After all, the sharemarket is a volatile beast. But you already know that, right?
In fact, the lack of volatility in the last few years is more unusual than the volatility we’re experiencing now.
The market can go almost anywhere in the short term, as it’s often driven by fear and greed. Lots of selling pressure (fear) pushes it down. And lots of buying pressure (greed) makes it go up.
By nature, this is a short term factor. But over the long term the market reflects how much value companies have created. More on that later.
Zooming out for a second, this page shows that 5 years ago the market was at 5,265. And 10 years ago, it was 3,722. (Yes I know it was higher before the GFC.)
Now let’s stretch our time-frame a bit.
In this data series, in 1992, the market index was at 1,358.
What stands out to me is how crazy (and way above trend) the boom leading up to the GFC was!
Clearly it’s not always smooth sailing. Far from it! But the point remains the same – over time, the market goes up.
The exact numbers aren’t all that important. The long term trend is what matters.
OK, maybe 26 years isn’t really that long. Let’s go back a bit further…
Basically the same story here. Some very shaky times, but ultimately, a relentless march upwards over 80 years.
The chart is from this page, which contains lots of great info on the history of the Aussie sharemarket. Well worth a read.
By the way, none of this includes dividends. We’re simply trying to put these price movements in perspective. Again, we see the same persistent long term trend.
In short, the market has increased many, many times in value from where it was 30, 50 and 80 years ago.
Our friends in the US always have mounds of data and examples of long term market returns and events throughout history. In Australia, sadly, we often have to get by with very little long term data.
But no more! The prayers of us financial nerds have been answered!
As luck would have it, while writing this blog post, the Reserve Bank of Australia (RBA) published a speech/paper called “The Long View on Australian Equities”, which is very interesting.
Purely coincidental – I’m not that well connected, I can assure you!
Anyway, there’s some great commentary and charts inside. Here are some of the best bits…
This chart shows that from the period since 1900, the total return from Australian equities would have multiplied an investor’s money by 1,000 times, after inflation.
And the following chart shows the total return for 100 years, broken down by indices and measured in nominal dollars…
Here, the total return comes to well north of 50,000x. Now, this isn’t adjusted for inflation, but still!
Also, it’s quite remarkable how close the returns have been for the indices over the very long run. Does this put the industrials vs resources debate to rest? I’ll let you decide.
But as I said in the Whitefield review, I’m no longer sold on the view that industrials will always win. A number of resources companies have proven they’re definitely worth owning as part of a diversified portfolio.
Now, how has Australia fared compared to other countries?
Pretty solid returns all round.
Let’s not forget, during those 100 years, we had the following:
Two World Wars. A number of market crashes. Political turmoil. An oil crisis. Terrorist attacks across the globe. And many terrible recessions, including the Great Depression of the 1930’s.
Despite that, shares have delivered the returns you see above. So it’s not a case of avoiding the market when bad things might happen. It’s about continually investing in the market, despite those bad things happening.
When investing in the sharemarket, this is the truly long term view we need to take. Sure, we might not quite be investing for 100 years, but we can stay invested throughout our lives, keep adding to our portfolio and gift that ownership to our chosen charities or children.
Ultimately, our loved ones and the rest of the world can then benefit from our foresight and strength to stay invested throughout the ups and downs.
All this after we’ve claimed our financial independence of course.
So, where is the market going in the short term? I have no idea.
But where is the market going over the long run? Up!
The market index tracks the performance of all the companies in a particular index – the top 200 on the ASX for example.
Each company in the index is weighted according to its market cap. So the biggest companies by value (like Commonwealth Bank and BHP) have the largest weighting in the index.
Over time, as companies slowly increase their profits, this makes them more valuable. And over time, share prices will eventually reflect that performance – for each individual company and the market index as a whole.
So, in the long run, the market goes up to reflect the higher profits made by these companies.
Because every day, those businesses (and the people who work there) are trying to come up with faster, better, cheaper ways to do things.
They’re each trying to beat their competitors, gain market-share and win over customers.
So they create new products and services, find ways to lower costs and increase productivity, which ultimately increases company profits over time.
Also, population growth means more customers. Simply put, businesses find a way to sell more things to more people over time.
A major way companies increase profit is simply by expanding, using retained earnings. This is best shown by the following table…
Quite simply, if a company makes $10 in profit, it will keep some of it to be reinvested back into the business. This should result in more profit next year, and so on.
Over time the company keeps growing in size, continually reinvesting to increase its future earnings. All while keeping shareholders happy with an increasing stream of dividends.
And it’s roughly like this for all the companies in the market index (or inside our LICs). Although they may be paying out healthy dividends, each business is still reinvesting and working hard to grow future earnings.
That could include anything from spending on research and development, investing in new technology or equipment, expanding a factory or just opening a new shop.
So it makes perfect sense why company earnings grow, dividends increase and the market goes up over the long run.
And because Australia is a prosperous, relatively well managed and stable country, with bright people and solid population growth, I don’t see this changing any time soon!
Look, I won’t sugar-coat it. The sharemarket is probably going to have a few pretty dramatic falls over the course of our lives.
I don’t mean 10% drops. More like 30% drops. Maybe even a few 50% drops. And when it happens, don’t be surprised. It’s not a bug of the markets, it’s a feature.
That’s just what happens. See my other post on this topic: What if Australia Crashes?
So we can either accept it, or we can freak out about it. But we can’t control it. And I think that’s what scares people the most. Not being in control.
What we really need then, is some coping mechanisms. Some rules of thumb to go by. And a plan of attack for when these situations occur, so we don’t get all nutty and panic at the worst possible time.
We already understand why the market goes up over time and why we can expect that to continue. But what do we do when we see that red in our portfolio? Is there a way to get comfortable with a sliding sharemarket?
Yes, I think so. At least, from my admittedly limited experience.
I don’t have war stories from the GFC. Nor do I have memories from the 1987 crash (I wasn’t even born then!). But I do have a decent list of things that should help us stay calm and level headed in scary times.
Stop looking at the market. Seriously! You’re just going to make yourself more anxious.
The more you look at it, the more your mind will start playing tricks on you, and come up with reasons why this time is different and you should sell everything and run!
Go for a walk. Read a book. Play with your kids/pets. Do anything else, other than look at the market!
Regular readers will know that I don’t really focus on share prices too much. Even writing the earlier parts of this article were a bit of a stretch for me.
I just don’t find the price movements all that important, because that’s not a part of our personal goals. We don’t need the market to go up. We want company earnings and dividends to go up.
Remember, the earnings drive the market in the long term. Not the other way round! So focus on the cash generated by companies, not the price they’re selling for.
I know that’s painfully simple. But it’s still important to remember.
A downturn this year isn’t going to matter much in 20 years time. Especially so, since you’re going to be investing regularly and reinvesting your dividends.
Don’t sweat the small stuff. In the markets, that means the short term stuff.
Trust that over the next 50+ years the world and the Australian economy is likely to be much larger, and company profits much higher, as technology and innovation makes us all wealthier over time, as it has for the last 100+ years.
The large basket of companies you own inside your index fund or LIC will change around a bit. But that’s normal. No company lasts forever. As companies become less relevant over time, they eventually get removed from the fund and replaced by newer, more successful companies.
We have no control over the market. But we do have control over how we behave.
So we need to stay calm and divert our energy elsewhere. That energy is far better spent on enjoying our life, increasing our savings rate or simply sticking with our investment plan.
Don’t bother try trying to guess where the market’s going next. You don’t know. But don’t worry, neither do I! And don’t read articles or interviews with market pundits, because they don’t know either!
By the way, that’s actually a blessing. We don’t have to know. We just have to keep saving and investing regularly, be strong enough to stay invested, and focus on our long term income stream.
When the sharemarket is down, is the prime time to be topping up your holdings. And even buying more than you normally would if that’s possible. Maybe by doing some overtime at work, or finding a few more incremental savings.
How do you know shares won’t go lower?
You don’t. We can only know that looking back years later. But either way, you’ve increased your ownership and will now receive higher dividends because of it.
When prices fall like they have recently, the dividend yield is now higher. For dividend investors, that should be enticing enough!
I think this is what the average person on the street struggles with.
They see (or hear about) the market going down. And they know individual companies can go bankrupt. So they put all that together and think “holy crap, you can lose all your money in the sharemarket.”
But the market can’t go broke. It’s just not plausible for the 100-300+ major companies that make up the Aussie market to all go bankrupt at the same time and have a combined value of zero.
That’s the difference between picking a couple of stocks and buying a diversified fund like an index fund or an old listed investment company.
Unless Planet Earth itself is coming to an end, the sharemarket isn’t going anywhere. It will continue to reflect the prosperity and efforts of the human race, and that’s the fundamental reason I believe it will continue to rise.
I’m an optimist by nature. And history suggests it pays to be that way.
If we’re expecting a dim future, why bother investing? Just buy baked beans and bottled water, and head to your underground bunker instead.
We all suffer the same emotions. It just takes a little effort and discipline to stick with our plan.
A great quote from experienced investor Peter Thornhill regarding the GFC: “you’d have to be dead not to feel it!”
So the point is, we’ll all get worried when the next crash comes around. But if we have a solid strategy in place and remember some fundamental truths about the market, we can feel the fear and invest anyway.
It’ll probably feel like the world has changed and we should be ducking for cover. But remember, the scariest times to invest usually turn out to be the most profitable.
Look at the long term price charts above, and tell me when you wish you had invested? At the lowest points right? Or simply whenever the chart begins, and then held up until the present day!
Try to look at the sharemarket with fresh eyes. Pretend you’re a new investor again.
Re-learn how long term investing in shares works, and more importantly, why it works.
Remember why you’re investing in the first place. Accept that falls and crashes are part of the deal. Not to be feared but to be expected. And those scary times are partly the reason why shares offer higher returns than other assets over the long run – to compensate for the risk.
Talk to investors who have been in the game longer than you. That can help put things into perspective and remind you that the market will fall from time to time.
The important thing is to keep your head in the game and stick to your plan. You can even automate your investing to make it easier.
Finally, come back to blog posts like this one, or whatever helps you remember what long term investing is all about.
Anyone who is going to be buying a lot of shares over time, should be hoping for lower prices. Why?
Because then we’ll be able to do most of our buying at cheaper prices. And building our portfolio at lower prices and higher dividend yields, means a greater return when the market eventually increases.
Not convinced yet? Well, here’s Warren Buffett on the subject:
“If you plan to eat hamburgers throughout your life, should you wish for higher or lower prices for beef? Likewise, if you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?
Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because the prices have risen for the ‘hamburgers’ they will soon be buying.
This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”
Buffett has also said:
“I like buying more as it goes down, and the more it goes down, the more I like to buy.”
Finally, here’s a short video with Uncle Warren explaining how he thinks about short-term market movements and long term investing.
For dividend investors, it gets even better.
Lower share prices mean higher dividend yields. This means our portfolio generates more income, sooner. It actually speeds up our progress!
And that’s true even if we experience a recession and dividends go down for a while. Because dividends fall less than share prices, the yield on offer will be very high indeed.
So if we can do more of our buying when there’s a bad patch, we’ll end up better off when the market and dividends inevitably increase again.
Market falls can prove to be heaven on earth for dividend investors!
Focusing on income instead of prices, makes riding the waves of the sharemarket a lot smoother. Especially when you consider that we’re not reliant on market prices to reach our goals.
Compare this to a capital growth focused investor, who is waiting for their portfolio to hit $X in value so they can retire and slowly begin selling down.
They could’ve been coming up on retirement this year as their portfolio grew nicely over recent years. Now they’ve been set back until further notice, simply because the market has fallen.
Your early retirement date is then dictated by market movements. Maybe that sounds OK to you, but personally, I’d find that incredibly frustrating and that strategy is not for me.
Anyway, for us dividend investors, we simply keep purchasing shares and watch our income relentlessly increase. Not because dividends never go down. But because our long term result is overwhelmingly driven by saving, regular investing, and reinvesting our dividends, as I highlighted in this post.
This means you don’t even need to look at the market.
I know that’s easier said than done. We all want something to look at! So what do we do?
Well, here’s what I focus on instead…
One big thing that helps, is by tracking the annual dividends generated by your portfolio.
You can do this on paper, on your phone, or in a spreadsheet. Whatever is easiest for you. I don’t have any formulas or anything, just the annual income from each holding.
Simply write down all of your holdings and figure out how much dividends you’re earning per year from each.
If you’re not sure how, here’s what to do…
Go to your brokerage account and see how many ‘shares’ or ‘units’ you own of each company. Then your broker should also have data for that company for how much ‘dividends per-share’ that company pays. Have a dig around and you should be able to find it. If not, type the code in here and find the dividends paid in the last 12 months.
For example, let’s say you own 1000 AFIC shares. AFIC’s annual dividend is currently 24 cents per-share. So 0.24 times 1000, means your annual income will be $240.
And of course, to add franking credits in, you take that number and divide by 0.7 (for a fully franked dividend). This gives you a figure of $343. Now you just add that to your table or list. Then on to the next one.
At the end, just tally up the total income from all your holdings. And adjust it every time you buy more shares, or your holding has a change in the dividend paid.
Update: Instead of doing this, you can get the simple spreadsheet I use to keep a tally of our Annual Dividend Income…
Now you really have something to look at! Of course, you can watch the market all day, but your annual income doesn’t move just because the market does.
Personally, I look at this when I need to remember what it’s all about, and it’s such a great help. So this can really allow you to ignore the mood of the sharemarket and let you focus solely on your income goals.
Remember, for dividend investors, the price movements just don’t matter. Simply keep your eyes fixed on your growing income stream.
Of course, it can be argued that prices move lower to reflect the less bright outlook, concerns over interest rates, trade wars, Trump’s tweets, whatever.
Maybe. But I don’t buy that entirely. I think it’s more a change in sentiment based on the short term, when the long term outlook (50+ years) hasn’t really changed.
With the amount of trading in the market skyrocketing and the average holding period shrinking, I think it’s fair to argue that the market in the near term is driven mostly by short term thinking.
Personally, I don’t believe the market moves based on the next 50 years of earnings. Simply what people think will happen in the next year or two.
For example, expectation is growing that the US falls into a recession in the next few years, which obviously will lead to lower stock prices and lower earnings. So some investors are getting out now just in case.
But that’s not our game. Dancing in and out, trying to read the tea leaves and outsmart the market is an utter waste of time, effort and money. Because you’re going to lose in the end.
We’re playing the long game here. So unless you expect the future to be a nasty, scary place, then the only rational thing to do is buy more shares.
Basically, I don’t believe that where we’ll be in 2068 has changed too much from a couple months ago!
The power of technology and innovation will continue to drive productivity gains, increase company profits and increase our standard of living over the long term. Just as it has for the last 100+ years. And that’s what will drive the market over the long term.
Hopefully you find this post helpful in navigating the choppy sharemarket seas!
Have a look at those long run charts from the RBA again. How can you lose money in the market during a time like that?
Irrational behaviour, lack of diversification, or trying to time the market. Luckily these things are easily fixed…
By keeping calm, understanding how the market works and focusing on the long term. By investing in diversified funds like low-cost LICs or index funds, including international shares if you like. And finally, by sticking to your investment plan and buying shares on a regular basis.
I’m building my portfolio each month, regardless of what the market does. Why should I let the market convince me otherwise?
If anything, I’m becoming more interested buying shares now than I was a few months ago, when prices were higher and yields lower. Remember, if we wait, then we stagnate, and end up making no progress.
After all, our sole aim is to constantly increase our ownership stake in a large group of businesses, which will, on average, increase their earnings and pay us higher dividends over time.
So focus on the income. Focus on your goals. And focus on the next 50 years, while the rest in the market worry about the next 50 minutes.
As Jack Bogle wisely put it, “the stock market is a giant distraction from the business of investing.”