Why switching during a downturn may not be a great idea
Why switching during a downturn may not be a great idea
Given the market turbulence across the first half of 2022, it’s natural to feel concerned about your super. You might even be considering shifting your super to more defensive investment options.
However, switching out of risky assets after a significant market downturn can do more harm than good to your super — especially over the long term.
Here’s why switching your investments during a downturn may not always be the best move.
Market timing is tough
Market timing, where investors switch between asset classes based on market predictions, is notoriously difficult. So much so that even professional fund managers don’t have a strong track record of constant out-performance.
That's because forecasting and executing market timing with success is complex. It requires investors to identify correct signals to both enter and exit the market, execute the transaction efficiently while ensuring costs and taxes are lower than the expected benefit and determine the appropriate allocation size.
A 2021 study by researchers at Duke University in the US showed that the investment funds that try to dynamically increase or decrease risky asset allocations have historically underperformed funds with an equivalent static strategic asset allocation by between 1.77% to 5.15% per year1.
The fear of missing out is real
Even when investors get their market timing calls right most of the time, gains are likely to be marginal and being out of the market for just a few days can be costly.
A bit of history may help to demonstrate this.
Between January 1928 and June 2022, the US share market was open for trading for 23,437 days. If you invested $10,000 in the US market at the start of 1928 and left that investment untouched until 30 June 2022, it would have grown to a value of $2,131,410.
If the same $10,000 was invested in 1928, but you took your money out of the market for just the best 25 out of those 23,437 days, your balance would only be $209,543 today2.
You would have lost $1,921,867 by only missing 25 days!
Figure 1: Current Value of $10,000 Invested in 1928
It also helps to look at when the best 25 days on the share market have occurred — almost exclusively during significant economic downturns where investor sentiment was low. But occasional days of good news were accompanied by large jumps in markets.
Most of those days (19 out of 25) occurred during the so-called Great Depression between 1929 and 1939.
Two of the best days in share market history were also during the Global Financial Crisis (13 October and 28 October 2008), while a further two occurred during the peak of concerns about the COVID-19 pandemic (13 and 24 March 2020).
Each of these were likely periods when investors were actively considering a switch out of risky asset classes.
Outcomes from switching during the COVID-19 pandemic
The impact of COVID-19 also shows us the risks involved in switching investment options at the wrong time.
Assuming a member had perfect foresight as to how the virus would affect the economy, she may have switched from the Balanced (MySuper) option to the Cash Option at the beginning of 2020.
The figure below shows the relative returns of a member in the Balanced (MySuper) option and the Cash option across 2020.
While the Balanced (MySuper) option suffered material drawdowns across February and March 2020 that the Cash option didn't, it still ended the calendar year more favourable.
Figure 2: Balanced (MySuper) option vs Cash option across 2020
While market timing has historically proven difficult, economic theory suggests diversifying across asset classes across a long investment horizon is the most effective way to weather downturns.
For example, periods of elevated inflation may create headwinds for the fixed interest asset class while benefiting Infrastructure assets. A diversified portfolio that includes exposure to both asset classes should smooth out performance across periods of high and low inflation.
Super is a long-term investment and should always be evaluated accordingly. Across the 10 years to the end of June 2022, our Balanced (MySuper) 0ption returned 7.91% per annum to accumulation members and our Balanced option returned 8.87% per annum to pension members.3
Rather than trying to time the market, we recommend you consider your personal financial situation and seek professional advice when considering which investment option is appropriate for you.
Our Superannuation Advisers are a great place to start and offer helpful, straightforward advice to ensure your super is working for your situation.
Advice about your super comes at no additional cost – it's part of the Spirit Super service.
Advice on Spirit Super is provided by Quadrant First Pty Ltd (ABN 78 102 167 877, AFSL 284443) and issuer is Motor Trades Association of Australia Superannuation Fund Pty Ltd (ABN 14 008 650 628, AFSL 238718), the trustee of Spirit Super (ABN 74 559 365 913). Consider the PDS and TMD at spiritsuper.com.au/pds before making a decision. A copy of the Financial services guide for Spirit Super Advice is available at spiritsuper.com.au/financial-services-guide.
Past performance isn’t a reliable indicator of future performance. The value of investments can rise or fall, and investment returns can be positive or negative.
1 McCarthy, J., and Tower, E. 2021. Static indexing beats tactical asset allocation. The Journal of Beta Investment Strategies. 11-12 (4-1), 41-52.
2 Past performance isn’t a reliable indicator of future returns
3 Past performance isn’t a reliable indicator of future returns.