Financial advice: What should I do with my pension fund?

Making Cents

I received an email from a gentleman a couple of weeks ago and it read as follows: ‘Liam, last week all I could see on social media and TV outlets were headlines saying that stock markets around the world were tumbling which got me worried about my pension. I’m 15 years away from retiring and my fund has taken a hit so I’m not sure what to do. I haven’t seen or heard much in the past week about markets so I’m thinking they have settled down but I’m not sure either. Have you any advice with what I should do with my fund? Should I put it all into cash?'

And because it was a great question and because I received many others like it, I wanted to devote this article exclusively to it rather than sharing it with other questions I which I normally do.

So, here was my answer to him.
Those headlines you saw were alarming but the reality of what actually happened to markets was not that unusual.
Let me explain.

A 2.5% to 3.5% drop in US and European markets is not that unusual and I say that because according to historical data there’s a 94% chance that markets will reduce by 5% in any given year, so volatility with markets is actually quite normal.
And according to Oxford Economics, who are one of the world’s leading independent economic advisory firms, drops in equity prices of 5% or more have occurred at least once a year for the past 40 years. And in a report, they produced they also said market corrections, which are drops of at least 10% from their highs, occur on average every one and a half to two years.

Anyway, the reduction in stock market values that you’re referring to got headlines because for a lot of stock markets indices it was their biggest one-day drop in nearly two years.

But what happened specifically in Japan was an unusual event ie they saw the Tokyo stock price index, commonly known as the Topix, fall by 12.2% in just one day which was the biggest drop since 1987’s Black Monday fall, but there was a specific explanation for that happening.

What has been described as a spectacularly poorly timed decision the Bank of Japan chose to hike interest rates for only the second time in 17 years, causing the Japanese yen to strengthen considerably against the dollar. This resulted in the unwinding of the popular carry trade.

Let me explain what a carry trade is. A carry trade is a strategy that involves borrowing at a low interest rate and investing in an asset that provides a higher rate of return.

And because Japanese interest rates have been low for a very long time, investors have been taking advantage of this, but when the Bank of Japan rose interest rates to 0.25%, which was their highest level since 2008, the impact caused carry trade investors to close out their positions by selling equities and this in turn appears to have been the main reason for the sharp movements in the Japanese market.

And along with this event happening in Japan, there were other factors that spooked investors in the US and Europe ie concerns about US growth and them possibly entering a recession, big tech/AI valuations and because of these high valuation levels, expectations for company earnings were also high and whilst earnings have been strong with many of these companies, they haven’t been exceptional either and a few notable companies ie Tesla, Intel and SMC announced poor results.

And then there was news that Warren Buffet, largely viewed as one of the greatest investors of all time, had sold down over half of his stake in Apple, a significant component of the Magnificent Seven leading stocks.

Okay that’s the boring bit out of the way but important to know and be aware of what happened, nonetheless.

So what does all this mean for the future? Although stocks did drop, sentiment appears to have improved markedly. Many commentators have noted that no singular catastrophe occurred, and the economy is not currently facing a significant emergency. And it was also reassuring when the US Federal Reserve came out quickly to reassure markets that the US is not in a recession.

And it’s too early to say at this stage whether any of the issues that occurred will persist and turn into a longer-term problem, but one very large Irish pension firm came out soon after the market drop saying that the long-term outlook in their opinion is positive across all asset classes.

For example, they are forecasting that over the next five years they will see annual returns in developed markets at 5.6%, US equities 5.2%, European equities 6.9%, Government bonds 2.90%, Irish property 4.5%, small cap equities 5.6%, Asian equities 7.2%.

And these are only forecasts, there is no certainty that any of these returns will materialise which is why you should have a well-diversified portfolio that includes equity holdings in companies located throughout the world, government and corporate bonds, cash, commodities, property etc.

So despite what’s happened to markets in recent weeks, in my opinion it isn’t a reason to panic and to make wholesale changes to your pension fund. And whilst there’s a temptation to move to cash to stop any further reductions, I’d say try and resist that urge if you can, and that especially applies to people saving for the long-term such as for retirement.

Trying to time the market in order to capture gains and avoid losses is not a road I’d travel because it’s incredibly difficult to achieve and it can lead to lost opportunities ie when markets rebound. Moving everything into cash is never a good investment because any loss you may have made is only a paper loss but if you move funds into cash, you are crystallising that loss and making it real.

So, my advice is to sit tight and push the patience rather than panic button. And people who are confident that their fund is aligned to their risk profile and are happy it’s well diversified, don’t micro-manage their portfolio every day, they barely even look at it.

And that’s because they know if they did, they could be duped into making a decision driven by emotion, which later turns out to be a poor one, but the damage could be done, and its impact could have a ripple effect on their fund for years to come.
So, they don’t overreact, they stay focused knowing whether their fund drops or increases in value, that over time, it will produce the returns needed for them.

The importance of holding firm and remaining calm can’t be underestimated, because if you do, and you believe in factual indisputable data, you’ll be fine. You know that similar falls in values have happened countless times over the past 50 years and on every occasion, markets recovered with some of the biggest rebounds happening following the biggest losses.

And here’s one last piece of factual data, I thought you’d like to know about, because some people are moving their fund from cash to equities, back to cash a day later, and they’re back and forth making decisions like a tennis ball going over a net during a long rally. One day it’s in the equity part of the court and the next it’s in cash.

If it’s on the cash side of the court for too long, it can ruin your longer-term returns. Because if you miss out on those days it should be in the equity side, it reduces your returns. You’re missing out on those days when markets perform very well.
I’m going to finish by telling you about one fund that was impacted by the stock market turbulence you referred to and this particular fund, which was all equity based, saw its value drop by -5.89% over a four day period.

But three days later it had grown back in value by 2.76%. So, if you were in this fund and you had moved everything into cash you would have missed out on those two days recovery. And here’s the thing, just 2 weeks later the same fund has grown in value by 5.94% so it’s now higher than it was even after that 5.89% loss.

And the fund I’m referring to has been in existence since 2001 and has been through the financial crisis in ’08 and ’09, it has been through Covid and many other events which resulted in some years having negative returns but despite that happening there were more good years than bad which is why the fund has averaged annual returns of 8.30% for the past 23 years.

So my key message is to be patient and whilst we don’t know what’s ahead, we do know that what’s happened to markets earlier this month has happened before, and there are patterns we can learn from. And the biggest one is that despite day-to-day volatility, the long-term returns of investing in equities are incredibly consistent.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie