This article was published on 27 January 2009. Some information may be out of date.

Getting in and out of share market a losing strategy

Many people with share investments — including KiwiSaver and other funds that hold shares along with other assets — are probably eying the 37 to 39 per cent drops in the New Zealand, US and Australian share markets last year and considering taking flight to lower-risk investments. Don’t.

Well, perhaps I should modify that “don’t”. If you are within five to ten years of spending the money, it’s a good idea to move gradually to high-quality corporate bonds and government bonds, which are less likely to lose value shortly before you take the money out.

Or, if the 2008 share market volatility really worried you, you might want to reduce your investment risk.

In both cases, though, it’s better if you switch firstly to putting any new money into bonds. If you feel you must also switch part or all of your current investment, I suggest you do it gradually, moving say a quarter of the money now, a quarter in six months and so on. That way you won’t move the lot at what turns out to be a particularly bad time.

If you do this, though, it should be a permanent change of strategy. Please don’t plan to move the money back into shares later on. Therein lie lower returns, as well as hassle.

Recent number crunching by AMP Capital — over a good long period — illustrates the folly of moving back and forth between higher-risk and lower-risk investments.

The researchers started out looking at an investment in a balanced fund, with 40 per cent in international shares, 20 per cent in New Zealand shares, 20 per cent in New Zealand bonds, 15 per cent in international bonds and 5 per cent in cash.

Then they came up with the following “switching strategy”: At the end of any calendar year of negative returns, you move into 100 per cent cash. And you don’t move back until the balanced fund generates a year of positive returns, and you want to be back in the action.

From December 1930 to June 2008, the switching strategy produced a real (inflation-adjusted) annual return of 3.1 per cent, compared with 4.2 per cent if you had stuck with the balanced fund.

The difference is not huge, but over long periods it adds up. A $100 investment in 1930 would have grown to $1,077 with the switching strategy, but $2,354 — way more than twice as much — in the balanced fund.

Other research gives similar results if you move between a 100 per cent share fund and a lower-risk fund.

“Okay,” you might say, “but I would know when the share market was improving and get back in sooner.” Don’t kid yourself. Even the experts can’t tell when a market has turned, as opposed to just blipping upwards. Trying to time markets is a fool’s game.

A more reasonable objection is that you’re not investing for 75-plus years. Over some shorter periods the switching strategy was the winner. And for all we know the same could happen over the next few years. But history shows it’s a better bet not to switch.

By the way, congrats to AMP Capital for adjusting their results for inflation. They look less spectacular, but they show the real situation. And in any case, improving your purchasing power 23-fold — albeit over a lifetime — is not to be sneezed at.

PS: A note to a reader called Janet of rural Canterbury, who sent me a Christmas card with a lovely, encouraging message but left out her address “just in case you feel a thank you for this communication is necessary.” I do want to thank you. Your message really lifted my spirits.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.