Reframe sharemarket volatility to help you keep your cool when the market drops. After all, there is no gain in reacting to short-term market prices.
On Monday 16 March 2020, as COVID fears spread, the Australian sharemarket (S&P/ASX 200) fell by its biggest daily percentage on record, losing almost 10 per cent.
The S&P/ASX 200 was now down 30 per cent from its peak on 20 February. No wonder many investors panicked and sold their assets and went to cash.
And yet, ironically, these investors were part of the problem.
Why? Because the sharemarket is simply millions of individuals like you and me making decisions on whether to buy or sell our shares at a given price on any given day.
Crashes like the one in March 2020 typically occur when an unexpected negative event – like the coronavirus – sparks a sudden, extreme stint of selling. And as more sellers (and fewer buyers) come into the market to offload their holdings, prices fall and keep on falling until the selling slows and opportunistic buyers enter the market to capture bargains.
To put it simply, frightened sellers cause market crashes.
The reality is that the sharemarket is by its very nature a market that is often volatile, with prices of shares sometimes shifting significantly each day.
Would you sell your house if its price dropped 10 per cent in a day?
Here’s a way to reframe sharemarket volatility and how you think about the inevitable ups and downs of the market.
Imagine your house. Now, think about its value today.
I’m guessing, you won’t be thinking of a number like $1,096,897.54. You’re probably thinking of a range, like “between $1.0m and $1.2m”. It’s nothing like the very specific value of the sharemarket – or the price of a particular company share.
Prices in the housing market are not clear. You can’t access a price for your house (or any other property) on any given day. And even if your neighbour sells their home – which provides a reliable price – that’s still only indicative of what the price might be for your place. Their house is not your house.
This doesn’t mean that house prices don’t fluctuate. They do. In fact, Australian house prices slowed or contracted during the 2001 to 2005 property finance collapses, the 2008-2009 Financial Crisis and the 2010-2011 sovereign debt crisis.
More recently, prices were also brought down by government-imposed lending curbs, first in 2014-2015 and then in 2017-2018. It’s just because most of us don’t think about selling our home on a daily or even monthly basis that house price volatility is simply not relevant.
Australian housing market volatility (1985-2020)
Now let’s imagine that your neighbour is moving interstate and needs to sell their home – which is very much like yours. They share with you that they have a price estimate in a range with a lower valuation of $1.2m. You feel pretty chuffed: “wow, my place could be worth more than $1.2m… it could be a good time to sell”.
The next day, your neighbour goes to auction. The successful bidder successfully negotiates to buy the property for $1,080,000.
That’s a 10 per cent drop from the price that was expected just the day before. What do you do now? Do you panic, and sell? Do you say to your partner, “The market’s dropped 10 per cent – we have to get out now!”
No, of course you don’t – that would be silly. It’s the same house it was yesterday, and it has the same value for you.
Has thinking about it this way helped you reframe sharemarket volatility?
No gain in reacting to a short-term market
The key message here is this: there is no gain in reacting to short-term market prices – whether it’s the property market or the sharemarket – and selling when asset values are low. Successful investors don’t sell when values are low – that’s when they buy.
As Warren Buffett has famously said: Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”