Sea change

balances are building up to a level where regular contributions will not be sufficient to offset a drop in unit prices. There will be plenty of opportunity over the next two or three years for nervous investors to make bad choices about how their funds are invested.

Let’s be clear on a few basics. Volatility is the reason shares provide higher rates of return than bank deposits. It is nothing to be afraid of; it just needs to be managed.

There are two key principles for managing volatility. The first principle: your investment in shares must be diversified to reduce risk. The second principle: you must match your investment strategy to your investment timeframe. When investors lose money by investing in shares it is because one of these investment principles has been violated. If you are in KiwiSaver, diversification is covered off by your fund manager – no worries there. However, your choice of investment option is critical and it must match your investment timeframe.

The problem is, many KiwiSaver investors haven’t thought through what their investment timeframe is. It is probably not the time at which you retire. Young KiwiSavers have an opportunity to use KiwiSaver funds to purchase a first home. In that case, their investment timeframe is the time at which they expect to withdraw their funds to use as a house deposit.

The shorter that timeframe, the less exposure to shares they should have in their KiwiSaver fund.

For most other investors, KiwiSaver funds will be spent at some time during retirement, but not necessarily at retirement. If KiwiSaver is your principal means of saving for retirement, it would hardly make sense to spend it all at the time you retire. The plan should be to spend it gradually over the course of retirement. Given that the average 65-year-old lives to around 90, this means you will continue to invest for many years after the day you retire.

For investors with a long timeframe, short-term volatility is nothing to worry about. Good fund managers will find opportunities to buy shares cheaply during a market downturn. The best returns are made by buying at a low price and selling at a high price. Inexperienced or nervous investors do the opposite; they buy near the peak when everything looks good, then panic and sell when the market drops.

In times of volatility, always review your investment goals and investment timeframe. If they haven’t changed, then you shouldn’t need to change your investment strategy, unless it was flawed to begin with.

Make sure you have access to funds in stable investments such as bank deposits to cover your short-term spending, so you can ride out the changes in volatile investments. Then sit back and relax.

‘‘The recent volatility in share markets is a timely reminder that we need to prepare for the next market correction. There is more volatility to come.’’