If you pay close attention to the value of your superannuation fund, and if like most people your money is spread across the main investment classes, you would have noticed that your retirement savings can both rise and fall in value. This can lead to some nervous times, particularly if you are close to or already in retirement.
What causes these ups and downs and can you do anything about them?
Start with how your fund is invested
For the most part, fluctuations in the balance of your super fund can be attributed to the portion invested in shares, and to a lesser extent property. In general, the greater the exposure to the share market, the greater the volatility (i.e. the bigger the rise and fall) in the value of your retirement savings. So, what drives share prices?
How much is an investment worth?
Let’s compare two companies, A & B and the profit per share that they are expected to generate:
|Year||Company AEarnings per share||Company BEarnings per share|
Which company’s shares would you pay more for?
The obvious answer is Company B’s. Based on current information, it is projected to generate much higher earnings and is therefore worth substantially more per share than Company A. That’s because, in very simple terms, an investment is worth the sum total of all of its future earnings.
It’s not quite that simple
Of course, there’s a catch: the future is a very uncertain place.
What if next year Company B announces that its profit is only $1.50 per share? Suddenly it looks much less valuable, and as a result its share price should fall. But company profit announcements aren’t the only things share analysts look at. They examine all sorts of issues in an attempt to anticipate what a company’s future earnings will be. Some are specific to the company, such as a change in CEO or launch of a new technology, whereas changes in interest rates or a jump in unemployment can affect the whole share market.
Aside from hard numbers, opinions count for a lot too. One investor may think that the fossil fuel era is coming to a close, that the earnings of coal and oil companies will fall and their share prices will drop. Another investor may think that the world will increase its demand for fossil fuels and expect those same companies to rise in price.
It is the collective opinion of all these analysts and share traders that set the momentary price of any given share. The combination of these collective opinions on the prices of the shares held by your super fund then determines how much your retirement nest egg changes in value.
This doesn’t mean that share price movements always appear logical. A company can report a stellar profit and still have its share price hammered if the market was expecting an even better result.
What to do?
The impact of share price volatility can be moderated by good diversification and by allocating a smaller fraction of the portfolio to shares. Just be aware that the latter can also reduce the potential long-term returns from your portfolio.
- Michael Finn