Major equity indices have been swinging between gains and losses as investors come to grips with rising inflation, higher interest rates, geopolitical turmoil, supply chain issues, and Covid-19 lockdowns in China. The S&P 500 is now squarely in correction territory, and Nasdaq-100 is in a bear market with an almost 30 per cent fall from its peak.
In early May, tech giants lost more than US$1 trillion in value with Apple's market capitalisation reduced by over US$200 billion. Cryptocurrencies also experienced a major meltdown with Bitcoin free-falling below US$30,000 and other top tokens falling to new lows. The crypto world is still reeling from the rapid collapse of the TerraUSD stablecoin (UST) which has majorly shaken the confidence of even staunch crypto loyalists.
We are also entering a period where inflation in the US is at a 40-year high, and inflation in Singapore accelerating to 5.4 per cent, the highest levels in the last decade. What should investors do to navigate these unpredictable times?
Take the long view
The market boom experienced during the last two years has made many investors huge paper gains. Everyone and anyone can be an expert when the markets are experiencing a bull run, but what happens when the music stops?
I would encourage those who are serious about investing to use this time to pause, take stock and go back to the fundamental basics of investing. Growing one's wealth is not a short-term endeavour and patience is key. As the "Oracle of Omaha" Warren Buffet said: "If you aren't thinking about owning a stock for 10 years, don't even think about owning it for 10 minutes." While I know this period hasn't been easy, history tells us that long-term investors will prevail.
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94 per cent of an investor's returns come from the right asset allocation
A diversified portfolio should be made up of assets that have no or low correlation. For instance, stocks and bonds are known to have a low correlation. When stock prices go up, bond values tend to go down. A well-diversified portfolio is one that has a meaningful allocation to multiple asset classes, sectors and geographies.
Long term studies have proven that asset allocation is by far the most important driver of long-term returns and performance. A 1986 paper by Gary P Brinson, Randolph Hood, and Gilbert L Beebower (known collectively as BHB) titled "Determinants of Portfolio Performance" published in the Financial Analysts Journal, concluded that only 6.4 per cent of the variation in a portfolio's returns was determined by market timing and individual stock selection. The other 93.6 per cent is derived from the mix and proportion of various asset classes constituting the portfolio, also known as asset allocation.
Traditionally, asset allocation is thought of in terms of capital. If you have $100,000 and you allocate $60,000 to equities and $40,000 to bonds, you'll have a classic 60/40 portfolio. Through periodic rebalancing, you'll then strive to maintain this allocation of 60 per cent equities and 40 per cent bonds.
Risk budgeting is a way of thinking about asset allocation in terms of risk, where the overall risk of the portfolio is distributed among various asset classes. When investors take up portfolios with the appropriate risk levels for themselves based on their life stage, time horizon and risk appetite, they are better able to withstand short-term noises in the market, and are more determined to stay on course for the long-term.
Keep more of your return by minimising costs through passive investing
Studies have shown that actively managed funds, also known as mutual funds or unit trusts, almost always underperform passive investments in the long run. According to the S&P Global's SPIVA US Scorecard for 2021, more than 85 per cent of actively managed US large-cap funds underperformed the S&P 500 over a 10-year period.
Over the years, passive funds have grown in popularity. In 2021, passive funds raked in US$958 billion, over US$700 billion more than their active counterparts.
In passive investing, portfolios can be built with exchange-traded funds (ETFs). Instead of paying large amounts of money to fund managers who claim they can pick the right stocks, passive investors pay a low fee to buy a broadly diversified basket of stocks that mimics a market index such as the Standard & Poor's 500 index (S&P 500).
Add defensive plays to your portfolio
Surging prices can be a strain on our wallets. In addition to stocks, bonds and gold, investors should also consider other assets such as REITs which typically outperform when inflation is moderately high. As prices rise, so do rents. This increases the amount of rental income REITs can earn. Singapore REITs (S-REITs) stand out for their resilience compared to their global counterparts. In the first quarter of 2022, the iEdge S-REIT Leaders Index gained 1.3 per cent while global REITs fell 3.8 per cent and the S&P 500 declined 5.5 per cent.
In periods of high inflation, cash is not always king. With inflation at a 10-year high in Singapore, we lose purchasing power on our savings. Another option that many investors have turned to in this time is cash management solutions, to ride out the volatility. A low duration (about 6 months) cash management solution also helps; as underlying bonds mature, proceeds will be reinvested into higher yielding bonds relatively quickly. Gains will be passed on to the investor in time to come.
Stay the course
The market may rally from this point on, or it may not. What we do know is that, the longer you stay invested, the better your return prospects are. In fact, if you can hold your investments for a 20-year period, you would have historically come out ahead.
Whether there's rising inflation or low inflation, investors with well-rounded portfolios are likely to stay on course to meet their long-term goals. During times of market volatility, it becomes even more important to pay greater attention to the things one can control: diversification, asset allocation and cost.
The writer is founder and CEO of Syfe
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