Interest rates increased after COVID
Approximately three years ago, the global COVID-19 pandemic began. Since that time, we’ve had entire countries shut down, globally distributed vaccines, restrictions to cross-border travel, and an eventual gradual reopening. In an effort to minimize the economic impact of the shutdowns, governments around the world provided trillions of dollars in support through federal subsidies and low interest rates.
With an excess of money in the system and an imbalance between supply and demand of goods and services, inflation rose globally to levels not seen in decades. Once the various countries reopened and economies were on solid footing, central banks shifted their focus to reducing inflation. Global central banks began to raise interest rates, some more aggressively than others.
A sizeable increase in interest rates, predominantly in North America, has exposed some individuals and companies who may not be able to weather higher costs during a slowing economy. Many of us may know at least one person who has felt the stress from rising interest rates, perhaps from an increase in monthly mortgage costs. Companies are no different, and to varying degrees, they may also be feeling the stress of rising interest rates.
Bank failures added to uncertainty
Most recently, market volatility ensued on the signs of trouble in the U.S. and European banking sectors. In the short term, volatility may persist as the market digests the ongoing fallout from regional banks and potential swings in prices in other areas of the market. As the economy digests the interest rate hikes from last year, we believe inflation will continue to trend lower (our view is 4% in the U.S. by the end of the year). And should that be the case, central banks such as the U.S. Federal Reserve, are likely getting close to ending their rate hike cycle, if they’re not already there. In fact, headline inflation has started to decline in most emerging market economies in Asia.1 Many central banks in the Asia region have already made a dovish pivot—for example, Thailand and Vietnam.2
Any market volatility tends to cause the same uneasy feeling for investors, and they start to question their investment choices.
Making financial choices in difficult times
It’s not always easy to make wise investment decisions, and this is especially true during uncertain times. When we’re stressed, we tend to make choices more intuitively and are less likely to spend time carefully sifting through all the pros and cons. The trouble is that intuitive snap decisions won’t necessarily help us meet our long-term financial goals.
Daily availability to market commentary and data has likely shortened investors’ timeframes, as we’re more prone to have knee-jerk reactions to short-term events. As humans, we naturally have biases that we must overcome (such as loss aversion, where the pain of losing is more psychologically powerful than the pleasure of gaining).
We may all agree that we shouldn’t react to short-term events and make changes to investments that were based on our long-term plans. Our time frame for our long-term goals is likely to change depending on the stages of our lives. And while there are no guarantees, at its core, investing is trying to make decisions to increase your odds of success.
As the charts below illustrate, having a time frame of greater than three years increases those odds. The charts show returns and odds of being positive for four different time frames: 1, 3, 5, and 10 years. Three main points to note:
- Over the short term (1 year), the average return was highest but the range in returns was by far the widest. A maximum return of 54% (indicated by the highest green diamond) to a minimum return of –45% (the lowest red diamond). Markets are volatile in the short term and the odds of being positive are only 74%.
- Over the medium term (3–5 years), returns were approximately 8% with the shorter three-year term having a wider range. The odds of being positive are approximately 85%.
- Over the long term (10 years), the average return was the lowest at 7.3%. However, the range in returns was small. A maximum return of 17% to a negative return of –5%, with the odds of being positive at 92%.
The results of the historical data have shown: markets are much more volatile in the short term with big movements to both the upside and downside. But typically, over the medium to long term, the odds have been in investors’ favour of both a positive return and one that could help them reach their financial goals. Perhaps this quote from economist Eugene Fama best captures the essence of how we should approach our investments during periods of short-term volatility:
“Investing is like soap: the more you touch it, the smaller it gets.”
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