August 2011
Investment market volatility - a guide for
DC/AVC members
There has been significant turmoil in financial markets so far in 2011. This
has been driven by concerns about the level of Government borrowing in
the United States and Europe as well as the possibility of a further period
of recession.
Recent economic reports have been disappointing and measures by the EU
to address the problems faced by peripheral Eurozone countries are being
questioned. Also, credit rating agency Standard & Poor’s, has downgraded
the credit rating of long-term United States Government borrowing from
AAA to AA+.
In summary
Contents
1 Summary
2 Simple guidelines for
DC/AVC members
3 Market volatility
4 What should you do
when markets are
volatile?
- If you are not
close to retirement
- If you are close to
retirement
There have been a number of more severe “ups and downs”, or periods of
volatility in recent years, in both equity and bond markets. Volatile market
conditions highlight some of the investment risks facing members of DC
and AVC pension plans. While it is advisable to avoid knee-jerk reactions to
market events, members should make sure that their investment choices
are appropriate given the level of the risk they are willing to bear. This note
sets out some of the issues to consider.
Pensions are long-term investments, so most pension plan members - other
than those who are close to retirement age - have time on their side. During
periods of market volatility, it is generally appropriate to wait for some
stability to return before reviewing investment choices (see page two for
further detail on the factors that you should consider).
If you are close to retirement age, you may need to take more immediate
action. You should consider getting financial advice on the issues and
options open to you (see page three for further discussion of the steps you
should consider).
Some simple guidelines for DC/AVC members
■
Assess how much investment risk you are willing to bear on a long-term
basis but avoid ad-hoc reactions to market events.
■
Familiarise yourself with the funds that you are invested in.
■
Once you have chosen an investment strategy, it is generally advisable
to stick to it; trying to time investment changes during periods of market
volatility is difficult and may be counterproductive.
■
Pay particular attention to your retirement account if you are close to
retirement age; take advice and decide whether any changes are needed.
Market volatility
The chart below shows average managed fund returns over the past decade. This illustrates what we all know: markets,
especially equity markets, are volatile by nature.
Average Managed Fund Returns
40%
34%
30%
19%
Annual Returns
20%
21%
20%
12%
10%
21%
13%
10%
11%
3%
0%
-4%
-6%
-10%
-20%
-10%
-19%
-30%
-35%
-40%
1997
1998
1999
2000
2001
2002
2003
2004
2005
Calendar Year
2006
2007
2008
2009
2010
2011
(YTD 10 Aug.)
Average managed fund returns for each calendar year and YTD 2011 to 31 July 2011. Proxy return used for period 1 August 2011 - 10 August 2011.
Source: Mercer
What should you do when markets are volatile?
Changing long-term investment choices in response to short-term market movements generally does not serve well.
Knee-jerk reactions may not result in good decisions. It is also difficult, if not impossible, to get the timing right. Making
more gradual changes to your investment strategy can lessen this timing risk (i.e. the risk of selling when prices are
at a low point and so “locking-in” investment losses).
If you are not close to retirement
Most pension plan members - other than those who are close to retirement age - have time on their side. Pensions
are a long-term investment, so short-term market movements should not drive decision-making. However, periods of
market volatility may prompt you to reassess your ability and willingness to take investment risk. Many pension scheme
members may think hard about the level of their exposure to equities and other higher risk assets, and may consider
reducing some of the investment risk they take. You will need to review the range of investment funds available in your
pension plan. You can “mix and match” depending on your tolerance for the risks that go with each of the different
asset types.
However, if you change your investment decision during volatile market conditions, you may “lock in” investment
losses and you could miss out on any potential market recovery. There is a case for waiting for some stability to return
before reviewing investment choices. If you then decide to change your investments, as noted above, a series of gradual
moves may lessen the timing risk.
If you move to investments that are lower risk, your expected investment return will also be lower, so you may need
to consider saving more for retirement.
You may be tempted to reduce or even stop your pension contributions (if this option is available to you). However,
saving less for retirement will definitely reduce your future pension. It is important to continue to focus on the longterm goal of providing yourself with an adequate income in retirement. Regardless of market movements, that longterm goal most likely means that you need to save more, not less.
It may help to remember that when markets have fallen, any new investments you make in those markets (through
your future contributions) will be at a cheaper price than previously, and so you may be getting better value for money
for those new investments.
2
If you are close to retirement
If you are close to retirement, you may need to take more immediate action. In the first instance, you should check how
your retirement account is invested. If your retirement account is less exposed to the markets that have been volatile,
you may not need to worry.
If your retirement account has fallen in value, unless markets recover, your pension benefits may be lower than you
had expected. So what action can you take?
■
If you are concerned that your retirement account will fall further, you could switch (in a gradual way, depending
on how close you are to retiring) to lower risk investments such as bonds or cash. There are no guarantees that this
will produce a better outcome, and you could miss out on any possible recovery in the markets in which you had
previously been invested.
■
You may need to consider increasing your pension contributions over the period remaining until your retirement
date to help build your fund back up (if you are over age 60, you can avail of tax relief at your marginal rate on
pension contributions of up to 40% of annual earnings).
■
You could consider whether it would be possible to defer your retirement to allow more time to rebuild your
retirement account. Obviously, you would need to discuss this with your employer.
■
You can consider transferring part of your retirement account to an “Approved Retirement Fund” (ARF) when you
retire, instead of buying a pension income. This would enable you to stay invested and benefit from any potential
market recovery (but the extent of any such recovery, or how long it might take, is always an unknown).
■
You should consider getting financial advice on the issues and options open to you, taking account of your specific
personal circumstances. The Mercer Helpline (1890 275 275) can refer you to an independent financial advisor.
This briefing note does not contain investment advice. No investment decision
should be made based on this information without first obtaining appropriate
professional advice and considering your own personal circumstances.
3
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