- While it is impossible to control what happens in markets, you can make sense of these events by gaining a better understanding of relevant investment terms.
- Recessions, bear markets, drawdowns and volatility are all part of the world of investing and building long-term wealth.
- To make better sense of the many terms being used in the financial world, an expert explains some that are frequently used during market downturns.
While it is impossible to control what happens in markets, you can make sense of these events by gaining a better understanding of relevant investment terms, says Debra Slabber, business development manager of Morningstar Investment Management South Africa.
"Recessions, bear markets, drawdowns and volatility are all part of the world of investing and building long-term wealth. What matters most is our actions and habits during this time," she says.
In the hope of assisting investors to make better sense of the many terms being used in the financial world, she explains some of the terms often used during market downturns, like the one currently being experienced during the global coronavirus pandemic.
The term "recession" in its strictest definition means that an economy experiences two consecutive quarters of negative economic growth as a result of a significant decline in general economic activity.
During a recession, businesses experience less demand - they sell fewer products or services. These businesses then usually react to this by cutting costs and sometimes laying off staff in order to protect the bottom line and profitability of the business. When staff are retrenched, this leads to higher unemployment rates.
"While Covid-19 has certainly put a drag on the global economy, it remains to be seen whether it will have lasting effects on economic output. It is important to realise that recessions are a normal part of an economic cycle and every person will experience a few in their lifetime," says Slabber.
A bear market occurs when a market experiences a decline of at least 20%, usually over a two-month period or longer. Bear markets often arise from negative investor sentiment because the economy is slowing or due to the expectation that it will slow down.
Signs of a slowing economy may include a decrease in productivity, a rise in unemployment, a decrease in company profits and lower disposable income. When someone talks about having a "bearish" view, it means they have a pessimistic outlook.
The distinction between a bear market and a recession is that a recession is measured by a decline in economic output (GDP), whereas a bear market is identified by a decline in stock market values in excess of 20% over a prolonged period as a result of negative investor sentiment.
Conversely, a bull market is favourable.
Volatility marks how much an investment's price rises or falls. If an investment's price changes more dramatically or more often, it's considered more volatile.
Price volatility is usually expressed in terms of standard deviation, or how much an investment's price has fluctuated around its average price over a certain period. A higher standard deviation implies an investment's price is more volatile.
"Investments with more uncertain outlooks, like equities, are typically more volatile," says Slabber. "That is because equity returns are based on a company's profitability, which is difficult to predict. In uncertain market environments, like the current one, investors tend to be especially pessimistic about how businesses will perform, which can result in steep market declines."
Risk should be defined as "permanent capital loss" or the chance that you won't meet your financial goal.
"If you're far away from retirement, you have time to ride out your portfolio's short-term volatility and take advantage of longer-term gains that equity markets will generate," suggests Slabber.
Loss aversion is the theory that investors feel more pain when they lose a certain amount of money than they feel pleasure when they gain an equal sum. In other words, you would feel more discomfort from losing R1 000 than pleasure from gaining R1 000.
"Time and time again it has been proven that selling your investments in a downturn and giving up on your long-term financial plan is detrimental to a successful investment outcome," says Slabber.
* Compiled by Carin Smith