If there is one certainty in life, it’s that there’s always going to be some uncertainty.
Of course, there are times in our lives where there’s higher levels of uncertainty, which can be very stressful. But, to a degree, we all have to become comfortable with some level of ‘uncertainty’ and learn how to dance with it.
This is especially true with financial decisions. Markets never exhibit zero risk (i.e. no uncertainty). This blog considers how to financially navigate uncertain times, much like we are experiencing today.
Uncertainty can exist in three ways being (1) personal circumstances, (2) domestic uncertainty and (3) global uncertainty. Each is different and requires a different approach.
Personal uncertainly relates to your personal financial position. This can include things such as the risk of a change in your income, losing your job, unexpected bills, relationships and so on.
How to deal with personal uncertainty
When it comes to personal uncertainty, the best thing is to put all material financial decision making on hold. Typically, the uncertainty resolves itself within a few months or possibly a year. That is, your fears are either realised, or the risk evaporates. Either way, it is likely that sometime in the near future you will be able to resume normal decision making (management).
Remember, investing and building wealth is a marathon, not a sprint. There’s no need to put yourself under any undue time pressure. Instead, you must make deliberate and well thought out decisions – there’s no need to rush. However, of course, at the same time, you must consciously avoid unnecessarily procrastinating too.
It is possible (although rare), that the passage of time does not in fact eliminate the uncertainty. An example of this is when one of my clients was facing the prospect of his employer cancelling his project (i.e. redundancy) for many years. In this situation, we just had to accept this higher risk and proceed with implementing his financial plan. We held larger than usual cash buffers to mitigate some of these risks. In the end, the redundancy did eventuate, but not for many years.
Domestic uncertainty relates to matters that are unique to Australia. These can include things such as changes to taxation rules or economic health. A recent example of domestic uncertainty arose during last year’s Federal election campaign where the Labor government proposed making changes to negative gearing and capital gain tax. Remember that? That was less than a year ago!
How to deal with domestic uncertainty
Tax and superannuation rules are everchanging. Economies move in cycles (although it has been almost 29 years since Australia’s last recession – although we have almost certainly broken that streak already). Most of these risks (or uncertainties) are cyclical and will continue to be present for the foreseeable future.
The best way to deal with domestic uncertainties is through your investment strategy formulation. For example, you must have sufficient diversification in regard to items such as investable asset classes and ownership structures so that you are not ‘single point sensitive’ to a change in tax law. You must ensure your property investments are of a sufficiently high quality, so they are able to absorb the impact of a tax hike and still remain viable.
Put differently, your investment strategy shouldn’t fail just because of a change in law or the end of an economic cycle. For long term investors, these events should not be unexcepted.
Another approach is to price the risk into the transaction you are contemplating. For example, unemployment is projected to rise from 5.2% to 9.3% in the third quarter of 2020 and then back down to 6% by the end of 2021, according to Westpac’s Bill Evans. This could have a negative impact on property demand and therefore price growth. As such, if I was contemplating a property acquisition today, I would reflect this risk in the price that I offered. That is, I would be seeking to acquire the property for a price less than its intrinsic value to compensate me for the risk of buying today.
Global uncertainty refers to international risks and their potential impact on your investment performance. An example is the risk of the USA falling into a deep recession and the resultant impact on global consumption and growth. Or China reducing its appetite for our natural resources (e.g. iron ore, gas and coal).
These factors will have limited (or potentially no) impact on some asset classes, such as residential property, for example. This is why diversifying across asset classes is so important.
Of course, global risks (uncertainty) will have a greater impact on things like super and share portfolios. There are two things you can do to accommodate these risks.
How to deal with global uncertainty
Firstly, you need to have enough control and transparency over your super and/or share portfolio so that you can ‘underweight’ exposures to certain geographical markets. I’m not suggesting you take large bets. Instead, you can strategically tilt your allocations away from perceived risks.
Secondly, at the risk of sounding repetitive, diversification is the common thread underpinning successful investment methodologies. This not only includes geographical diversification but also industry/sector diversification, single company limits and filters to avoid over-valued segments of the market – traditional indexing doesn’t always achieve this.
Applying this approach to COVID-19
Depending on your situation, coronavirus can give rise to all three risks/uncertainties.
If your job security and/or income has or will be impacted by the coronavirus, then you may be best served by putting all financial decisions on hold and focusing all your efforts on recovering your income. For many people, there may be little they can do other than wait for the shutdown restrictions to be lifted.
If you are one of the lucky people that have not been personally impacted by the coronavirus, then your only risks are domestic and international ones, which can be easier to navigate, as described above.
Success lies in your decision making
Now more than ever you must only employ evidenced-based strategies and focus on the long term. Instead of asking “what should I invest in”, a much better question to ask is “how should I invest”. This forces you to focus on your strategy, not just the underlying investment. A well-thought-out strategy and methodology should go a long way towards accommodating many of the present risks and uncertainties. Of course, if you need help, do not hesitate to reach out to us