Dealing with a market correction
It is far too early for investors to assess whether the latest share market correction is an indicator of worse times ahead or just a temporary set-back before markets continue their upward movements. At this stage, there's certainly no reason such as the collapse of Lehmann Brothers, which triggered the global financial crisis, to expect the worst.
All indications are that the world economy is performing well. The US market correction followed an unexpectedly strong jobs report that removed any doubts that the Federal Reserve will increase interest rates at least three times over the current year. Even after the correction, US share markets are still way above previous highs and all but recent investors still have substantial capital gains on their holdings.
Despite not reaching pre-global financial crisis levels, Australian share prices have followed US and other world markets down, though so far at a slower rate. This sell-down has occurred even though there's little prospect that Australian interest rates will rise. The high percentage of overseas investors in our largest companies and the currently strong Australian dollar virtually ensure that our market will follow overseas markets down.
Against this overall background, local investors need to develop strategies to protect their medium and longer-run interests against being caught out by this and future market corrections. The best-placed investors are those who, because of their cash holdings or other income streams, do not need to rely on growth in their portfolio to meet their current income needs.
Being in such situations allows investors to continue to hold their investments until markets recover. This involves owning portfolios of quality assets with sound futures and generating regular income streams. Where capital growth is relied upon to provide a significant proportion of annual income, a downturn can seriously deplete the value of a portfolio if the need for cash forces to holdings to be sold when prices are down.
The investors most at risk of long-term losses are retirees and others without sufficient cash reserves or other means to fund immediate outlays. Retirees can benefit by holding the equivalent of at least two years' annual pensions in cash reserves or liquid quality fixed interest assets. Current low interest rates have induced many retirees to hunt for yield and into buying high-yielding assets including shares and property.
While there is a good chance that our market will recover quickly, nothing is certain. Building up cash reserves at current market prices is an option worth considering just in case markets have further to fall. Investors in tax-free pension funds are well positioned to take profits because paying capital gains tax is not an obstacle to managing their portfolios.