Diana Clement: Stand firm when others are panicking

Investors actually make more money when share prices are low, say those in the know. Photo / Bloomberg

Crashes are inevitable, but should be seen as opportunities, not crises.

Don't read this article. Yes, if you have money in KiwiSaver, shares or property, don't read on.

That's because it covers crashes, which inevitably happen. But our brains aren't wired to cope with our investments going down and can do quite the wrong thing.

One moment we're exuberant, thinking that Auckland property prices can only ever go up, or that bank shares will never fall. But they do, eventually, no matter what arguments investors use to convince themselves otherwise.

There are noises being heard from people who understand these things suggesting that sharemarkets and property markets are looking pretty giddy. The domestic sharemarket looks stretched, says Mark Lister, head of private wealth research at Craigs Investment Partners, and we all know what Auckland property prices are doing.

Even Finance Minister Bill English warned first-time buyers last week: "Right now they do need to be careful of buying in what could be close to the peak of the market when interest rates are really low."

So here's what happens with investment markets. Share prices and property prices can go both up and down, driven by supply and demand. Mostly they go up and we get used to that. When the market really starts rising exuberantly, we get overexcited and buy more of our pet investment at prices that can never be sustained, thinking all along we're on a winner.

Something then occurs that pops the bubble and when one person heads for the door the rest follow, selling their investments at a loss, and prices crash. Or no one wants to buy and prices go sideways until inflation does the same job as a crash.

It's how we react that matters. "What's going on in people's heads is a total lack of rational perspective," says Jeff Stangl, the president of the CFA Society and a senior lecturer at Massey University. "Investors buy when the market is high and sell when it's low [because] they get caught up in the euphoria or depression."

Property owners and investors who have partied all the way up the boom and keep topping up their mortgage to the hilt can be caught with their pants down and be forced to repay some or all of the money when markets fall, to reduce the loan to value ratio to an acceptable level.

The other thing that can happen is the underlying economy is affected and people can no longer keep up mortgage payments because they lose their job or business. In this situation they may be forced to sell at a loss.

When markets fall, investors often don't have the money to buy, when that's what they should do. Or they bail out, sit on the sidelines until things have "improved" - that is, prices have bounced back up - which is precisely what not to do.

KiwiSaver investors should turn a bit of a blind eye to short-term losses, providing their investment is diversified. The ups and downs are natural with the sharemarket investments on which their KiwiSaver is building. Yet I see a small number of the blind leading the blind on Reddit, Twitter, Facebook and elsewhere. Some who saw their teensy KiwiSaver savings fall in value in 2007/8 are still convinced it is a bad investment.

Fortunately, KiwiSavers can't sell. But they do the next worst thing, which is switch growth funds for conservative after the prices have already dropped.

Blair Vernon, director of advice and sales at AMP, points out one of the reasons readers should have recycled this page instead of reading it is that the volatility that can lead to fund switching at the wrong time also leads investors to stop contributing to KiwiSaver and other savings at precisely the wrong moment. Worrying about volatility, he says, puts at risk the desire to contribute and keep enlarging your fund.

Conversely, smart people view market corrections as chances to buy more shares or properties "on sale".

Mark Brighouse, the chief investment officer at Fisher Funds, says investors with strong stomachs are the ones that make money long term. Growth assets provide a higher return over time because the pain of market declines is unpalatable to some investors and this excess return is left on the table for those investors with stronger stomachs, he says.

The KiwiSaver investors who saw their investments fall sharply in 2008 and 2009 are a case in point, says Lister. The ones who held their nerve and stayed in growth funds were rewarded for their sensible behaviour.

"Ryman Healthcare, one of the best companies in New Zealand, fell to $1.14 in early 2009, and the shares are close to $10 now," says Lister.

Likewise Auckland Airport shares have risen out of the ashes of the global financial crisis and given investors some spectacular returns for those who held their nerve through the rough years.

The downturns that do our heads in and make us behave irrationally can be prepared for. "The best question for investors to consider," says Brighouse, "is not 'how do I predict market declines?' but 'how do I build a portfolio that will do its job in all conditions?'"

If you're in KiwiSaver, then the job is largely done for you. Managers diversify your investment with a mix of cash, bonds, shares and property.

The reality is that the next crisis (otherwise known as opportunity) is never far away, as Lister points out. "In 2012, it was Greece defaulting, five years before that it was the global crisis, five years before that it was the dotcom bubble bursting, five years before that the Asian crisis and five years before that it was the early 1990s and New Zealand was in recession. There is always something, but life goes on and the best-quality companies and the economy in general recover and move on to bigger and better things."

Yes, there will be down times. But over the course of their investment, investors will almost certainly do well if they hold their nerve, Lister says.

Market declines can be prepared for, even if we don't know when they're coming. With shares, it means owning good-quality companies and diversifying them; with property, it means limiting debt so that you're not caught naked when the tide goes out. And in general it means owning more than one class of investment.

With KiwiSaver, says Vernon, make sure you're in the right fund that matches your actual risk tolerance, not your return desire. That way you're less likely to panic come downturn day. Resist the urge, as well, to view your KiwiSaver account when you look at your bank balances.

The beauty of KiwiSaver is your contributions keep going regardless of what the market is doing, or whether the headlines are suggesting you should panic, says Lister.

Tony Walker, financial adviser at ImPower, makes a good point when he says we like to see our portfolios with high values, but actually make more money when prices are low. "Regular savers are buyers. And, as a buyer, I want things to be cheap. I want the supermarket to have my requirements 'on special'," he says.

If you want to avoid being caught, remember Warren Buffett's advice: "Be fearful when others are greedy and greedy when others are fearful."