The longer the party, the worse the hangover

Apart from the COVID blip, the New Zealand share market has enjoyed a decade-long bull market. It’s the kind of market that leads young investors to expect lightning-fast, sky-high returns.

Digital trading platforms such as Sharesies and Hatch tap into this belief. They’ve grown enormously popular because they’re easy to access and require only a small outlay. Their irreverence appeals to younger investors. You can add cryptocurrencies into this picture of hopeful people chasing the allure of great riches quickly.

It could be that using these platforms leads to an increase in financial literacy born out of experience. That would be a positive outcome, but it may also be an optimistic view. This behaviour looks more like gambling than investing and what experience tells us is the market can be a cruel teacher.

Markets go up as well as down

Many of those in the market today have generally only experienced rising prices. And it’s not just the share market that’s gone up.

House prices in New Zealand have recently been exceeding all expectations as well, but both property and equity markets don’t always go up. When they fall, they often fall fast and can stay down, not just for years, but decades!

By way of an example, imagine an investor entering the New Zealand share market in the winter of 1989. Following the crash of 1987, it was surely a time to get back in, right?

Let’s say they invested $100,000 in a portfolio of the 10 largest companies as represented by the NZX 10 Capital Index (as per the chart below), which accounts for the majority of our domestic market capitalisation.

Within 12 months the market fell 49% reducing the investment to $51,000 and wouldn’t regain its value again until the winter of 1997.

Any feelings of relief would prove to be short-lived as the Asian debt crisis, followed by the bursting of the tech bubble in 2000, rocked global share markets. These events sent our investor's portfolio back below the initial $100,000 investment for another half decade.

It then only recovered to its entry price again in 2006 where it enjoyed an 11-month spell in the black, slightly above the original $100,000. That was, until the global financial crisis (GFC) sent markets into another tailspin and our poor investor was staring at a portfolio balance -40% lower than their $100,000 investment from two decades earlier. A slow recovery finally returned our investor’s portfolio back above par in 2016, where this time it stayed and flourished - 25 years after they initially invested.

Now, our example ignores dividends which would have been paid along the way. Capital growth is often the primary motivator for share market investors. In that respect they share some similarities with many residential property investors who tend to brag about growth in their capital values but not about their rental income streams.

So, how will investors chasing quick wins deal with years of negative returns? And how will the firms and platforms themselves hold up when stresses mount?

Source: NZX 10 Index (Capital index, dividends not included), New Zealand Stock Exchange (NZX), Standard and Poors

The longer the party, the worse the hangover

As we said, the market can be a cruel teacher. How many investors will stay the course if their portfolio drops 25 – 50% over a 5-year period, let alone a decade? We have been in a bull market since the end of the GFC. That’s a long party. Most often, what follows a really long party is a really bad hangover.

Financial market regulators are often focussed on lowering fees for investors because costs are tangible and easy to measure. While fees are important, the documented behaviour of investors acting like gamblers can be far more detrimental to their financial health and well-being.

Regulation around this issue is admittedly difficult. What we do know is that professional human financial advice mitigates some of the marketing pull, and unfounded optimism that the markets will always rise and rise some more.

Expertise makes a difference

Getting advice from a qualified person is paramount, however financial advisers do charge for their expertise. Reassuringly, multiple studies have found that professional advisers add considerable value, largely because they help shape investor behaviour.

US company Russell Investments recently explored the value good advice can add to personal wealth. Their report showed that financial advisers can add at least an annual 5.2 per cent to the value of their clients’ portfolio even in difficult investment climates, and that’s after fees.¹

Perhaps unsurprisingly, a good chunk of that gain comes from helping investors avoid bad decisions. Steering them away from impulsive investments and encouraging them not to sell, for example, during the panic of a global pandemic. In fact, an FMA report showed that many millennial investors did just that by switching their KiwiSaver funds during the Covid-led market dip of March 2020.²

An adviser with a wealth of experience and wisdom can explain and recommend diversification, along with the benefits of spreading funds between shares, property, bonds and cash both in NZ and overseas. They can guide investors away from risky investments towards solid long-term returns. Financial advice can be as simple as setting up a plan for paying off a mortgage early, identifying retirement needs, and then choosing an investment and KiwiSaver plan that aligns with their goals. The everyday needs of everyday people.

That’s not particularly glamorous, but it is sound.

While platforms such as Sharesies have made DIY investing easy, experience and evidence have shown us that investing is anything but. What’s intuitive can often be misguided, and impulsive decision-making can often lead to poor long-term outcomes. In this arena, experience counts and advice from a professional who can help steer you in the right direction to reach your financial goals, adds a lot of value.

Article by Scott Alman

Consilium Managing Director

Sources:

1. How financial advice can add 5.2pc to your bottom line. Aleks Vickovich, 14 October 2020, https://www.afr.com/wealth/personal-finance/how-financial-advice-can-add-5-3pc-to-your-bottom-line-20201013-p564p9, accessed 8 July 2021.

2. Millennials hit hardest by Covid KiwiSaver fund switch. Daniel Smith, 17 June 2021, https://www.stuff.co.nz/business/money/300334789/millennials-hit-hardest-by-covid-kiwisaver-fund-switch, accessed 8 July 2021.

Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular investor’s objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.