27 April 2022
A two-year battle with COVID-19 has left many investors weary and looking forward to a sense of stability. But instead, the year has started with even more volatility. Global stock markets had a wild ride in the first 3 months of 2022 – most markets experienced their biggest quarterly declines since the start of the pandemic on the back of the Russian invasion of Ukraine.
At the same time, we’re seeing higher prices almost everywhere – from grocery stores to petrol stations, and even in our electricity bills. Inflation has reached its highest level in decades, because of the perfect storm caused by the war in Ukraine, supply chain disruptions, and returning demand after the pandemic.
In fact, over 40% of developed economies and over 70% of emerging economies saw their annual inflation rates rise above 5% by the end of 2021.
What does this actually mean? At an annual inflation rate of 5%, your current cash savings will lose half their value in about 14 years.
What’s more, higher inflation tends to go hand in hand with higher interest rates. This is because many central banks use interest rates as a tool to reach their desired inflation rate. When inflation is too high, these central banks typically raise interest rates to slow the economy down and lower inflation. Higher interest rates make borrowing more expensive – this means your mortgages, car loans, or student loans would cost more.
So, in an environment where it seems like there are no good options for savers or investors, what should you do with your money?
Markets tend to go up in the long run. While we’ve had a shaky start to 2022, global stock markets have already rebounded from their initial correction in response to the Russia-Ukraine war.
Also, if we look further back in history, we see that despite their human toll, wars and other geopolitical events don’t tend to have a lasting impact on the stock market.
However, no one can guarantee that the worst is over or that the market has “bottomed out”. In fact, inflation and geopolitical uncertainty could keep markets volatile – at least for the near term. While market fluctuations are beyond our control, there are steps we can take to feel more comfortable with staying invested for the long haul.
Your risk tolerance is your willingness to stomach a decline in the value of your investments. Everyone’s risk appetite is different, and your tolerance can change at different stages of your life and with different goals.
Once you’ve figured out your risk profile, make sure your portfolio reflects your current risk appetite. If you had set too high of a risk profile, you could face more losses than you’re comfortable with when stock markets drop significantly. So if you feel uncomfortable with the recent market volatility, consider lowering your portfolio’s risk level.
We use the StashAway Risk Index (SRI) to measure the probability of our portfolios losing value in a given year. When considering which SRI is right for you, you should also consider the time horizon of your investment plan. We recommend that you select a lower SRI for investments with shorter time horizons (1 to 3 years), and, if you’re comfortable with it, a higher SRI for longer time horizons. A longer time horizon gives you more time to recover from changing market and economic conditions.
The US Federal Reserve raised its interest rate for the first time in 3 years in March and recently signalled a more aggressive pace of rate hikes for the rest of the year. Since higher interest rates are here to stay, they’ll affect the different asset classes in your portfolio. Here’s how:
Rising interest rates have the biggest direct impact on bond portfolios. Bonds and interest rates have an inverse relationship, meaning that bond prices fall when interest rates go up. Longer-term bonds (such as those maturing in 10 to 30 years) are more sensitive to interest rate changes than short duration bonds, so one way to mitigate the risk of rising interest rates is to have more short-term bonds in your portfolio compared to long-term ones.
Within stock markets, the financial sector usually benefits from rising interest rates. Banks, brokers, and insurance companies tend to see their profit margins grow in this environment. On the other hand, companies that pay out dividends (like those in the utilities, real estate or telecommunications sectors) could see their share prices take a hit. Higher interest rates could increase their costs and affect their ability to pay dividends to shareholders.
At the end of the day, diversifying your portfolio is the best way to minimise interest rate risk. Even though bond prices may come under pressure when interest rates rise, exposure to bonds still helps balance the risk from the equity portion of your portfolio.
Once you’ve reviewed your investment portfolio, you should also take a look at your cash holdings. If you have an emergency fund:
Don’t keep it under your mattress – remember, inflation will erode cash value over time!
Don’t take on too much risk. Exposing your emergency fund to short-term market volatility puts you at risk of its value dropping just when you might need it.
Even if you consider yourself risk-averse, there are better options for your cash or emergency fund than leaving it in your bank account. We recommend keeping these funds in a liquid, low-risk account. Any interest earned will help lessen the impact of inflation on your savings, and high liquidity ensures that you can withdraw it on short notice. Our lowest SRI portfolios are a suitable choice for emergency funds.
We reoptimised your portfolio earlier this year to protect against inflation and take advantage of valuation opportunities, and we’ll continue to monitor the geopolitical events and the inflation rate environment.
Remember, it’s normal to feel nervous when markets are volatile. But ultimately, the basic tenets of investing still hold true: Diversify your portfolios and maintain a long-term view. And if your portfolio accurately reflects your risk tolerance, it makes it easier to stay invested for the long haul.