In the wake of this week’s rout in stocks, shocked investors are wondering what steps they should take to protect their capital – or whether doing nothing is the best long-term bet.
It’s a familiar conundrum, given that the market implodes every decade or so. But it’s not getting any easier and even seasoned investors won’t know if we’re heading into a bear market or preparing for another Covid-style miracle comeback.
For young investors, the “do nothing” scenario isn’t such a bad bet, assuming their portfolios aren’t filled with speculative resources or tech games. Throughout history, the market has never failed to surpass its previous high.
But older investors in retirement or nearing retirement may not have time to wait for such a rally – and not all cycles are the same.
Novice investors may be reassured by the extraordinary recovery of the market after a fall of more than 30% in the space of four months. Greybeards will remember the crushing decade-long recovery from the depths of the global financial crisis in 2009.
In theory, nervous investors should increase their cash reserve, with a view to reinvesting in stocks when the damage is done (not that anyone is ringing a bell then).
The problem is that with “trimmed average” inflation of 3.7% – and rising – risk-free bank deposits are shrinking. Canstar quotes the best three-year rate at 3.9% and five-year rate at 4.15% (both with AMP Bank, since you asked).
A combination of debt and equity, hybrid banking has always been popular. National Australia Bank raises $1 billion through its Capital Notes 6, with a floating yield set at a margin of 3.14% over the 90-day bank bill rate (currently 1.51%).
That’s a healthier yield of 4.65%, but one downside to hybrids is that investors aren’t covered by the federal deposit insurance scheme in the event of a catastrophic bank failure (and anything is possible).
Gold, maybe? Shiny metal is the enduring store of value, after all. While the price of gold hit a record high of just over US$2,000 an ounce in early March, it has stalled over the past year. Gold is favored by high inflation, but the conundrum is that high interest rates tend to work against it.
It makes sense to have some exposure to bullion, either directly or near-directly (through passive exchange-traded gold funds) or through ASX-listed gold producers.
The latter can result in returns well above the performance of bullion, but they can also suffer alongside other sectors during sell-offs.
Push me pull you
Many investors prefer to stay in stocks even though they fear more losses. One reason is to not pay capital gains tax, given that they are likely to be well ahead despite the setback.
One way is to protect against further losses with ETFs designed to move in sync with the market, but in the opposite direction. This is done by taking a “short” position in the relevant stock market futures.
For example, Betashares Australian Equities Bear Hedge Fund (BEAR) will gain between 0.9% and 1.1%, for every 1% drop in the ASX 200 Accumulation Index.
For real grizzlies, the strong bear version (BBOZ) exaggerates this movement: for every 1% drop in the market, the fund returns 2% to 2.75%. Unfortunately, the reverse is true, so jittery Nellies severely compress their returns if – or should – the market rally.
Similar vehicles are linked to the performance of the US market. For example, ETF Securities offers the Ultra Short Nasdaq 100 Hedge Fund (SNAS), which uses leveraged strategies to increase the magnitude of gains and losses.
Such a fund might appeal to investors who believe the tech sector’s decline (and thus the Nasdaq selloff) has yet to run its course. But the underlying mechanisms are complex.
As we have said, patient young investors may prefer to avoid such protection which, like all insurance, comes at a cost.
This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.