During a number of recent client conversations I have been asked how imminent another sharemarket correction (-20% fall) will be. This fear is typically derived from sensationalised media reports because as we all know, fear sells!

So, let’s look at some facts

From 1900-2016 the Australian sharemarket has risen in 81 of 117 years, as illustrated below:

Every now and again markets will suffer a negative year but not even the most astute investment manager knows which year this will occur.

And not all year negative years are catastrophic. The graph shows that a GFC event, where the All Ords fell by 40-50%, has occurred once in 117 years!

So what is more likely to occur?

Of the 22 negative years, the average fall was 12%. But when you combine the negative and positive years, an investor’s average return is 13.22% per annum. Furthermore, the market grew by around 8.5% per annum in 2017 and 2018.

Now that you have some context, when the market returns a negative year, how will it impact you?

Hewison financial advisers strongly believe in diversification. Diversification across asset classes, e.g. listed and unlisted Australian & International shares, fixed income, property and cash. Of course, the more you have invested in any one asset class, the more you will be impacted by changes to values (+/-) within that asset class.

Kate & Steve: a Case Study

• Kate and Steve have a portfolio valued at $3.75m
• 40% is invested in Australian shares, totalling $1,430,000
• The total portfolio generates income of around $190,000 per annum, or 5%, (regardless of capital movements)

The following tables shows the capital impact of Australian share movements:

Key Takeouts

• Cash flow is king! Market movements generally do not impact the income and dividend distributions of investments. Often price movements do not relate to the underlying company performance.
   
• Diversification matters. The extent of diversification depends on the goals and investment timeframe of the individual. If you can cope with volatility, over the long term a higher exposure to growth assets should result in higher returns. But then there’s the ‘sleep at night’ factor to consider, how much volatility can you handle?
   
• Understand the facts. In this scenario a 20% sharemarket fall results in a -3% return due to the benefits of diversification and underlying cash flow.
   
• Market downturns breed opportunity. If you are a long-term investor, often market declines present opportunities to invest in quality companies that have been unnecessarily dragged down by general market movements. This is a value add opportunity!
   
• Stay Informed. Some media can be fear mongers. Market falls are a fact of life but do not need not be concerning. The true impact of a 20% fall in your portfolio may not be as drastic as some would have you believe.