In one of the worst days for Australian shares since February, Thursday's trade saw 2.7 per cent wiped off the ASX 200 to send it to a five-month low, as most shares ended the session down. The market has so far failed to make back losses in inter-day trading on Friday.

Tremors were felt around the world, with major indexes in Europe falling more than 1 per cent in early trade, as the S&P index dropped 3.3 per cent, the Dow 3.2 per cent, and the NASDAQ 4.1 per cent. Asian markets are on track to experience their worst October since 2008. 

Morningstar’s director of equity research Adam Fleck explained that the rout is all down to the US central bank, the Federal Reserve’s, interest rate policy.

“The slide in the US market has spilled over into the Australian market primarily because of rising interest rates, rising yields and rising discount rates as a result,” he said.

“A rising interest rate means that you can get a higher yield at lower risk, and therefore going to discount your future cash flows of your equity investments at a higher rate. That leads to a lower valuation that you're willing to pay for stocks and the slide that we're seeing in today's share.”

What can investors do?

As panic grips markets, Morningstar Investment Management’s chief investment officer Dan Kemp offers some sage advice for investors – ignore the noise and focus on the long term. 

"Periods of market volatility can be especially dangerous for investors as they tend to elicit an emotional response and heighten the behavioural biases to which we are all prone," says Kemp. 

"Left uncheck these biases can lead to us making poor decisions which can harm long-term investment returns." 

Kemp says investors should find ways to overcome these biases and offers three tips for riding out market volatility: 

  • Gain perspective. Remember that investment is a long-term pursuit and put all recent price movements in this context. While a 4 per cent fall may feel a lot, it means little in the context of a 10 or even 20-year investment horizon. Try to avoid the sensational headlines that can lure you into action.  
  • Look for buying opportunities. If you are going to look for buying opportunities, ensure that you have a robust framework for setting the real value of assets. This will provide an anchor for your expectations and help you avoid overreacting to short-term price movements.  
  • Sit tight. Remember that investors tend to make too many decisions rather than too few. So, if in doubt, do nothing. 

Morningstar's director of personal finance Christine Benz says investors should stay true to their investment goals, regardless of the market’s moves. She says that sticking to a plan will not only give investors more confidence but serve to distract their attention from unhelpful activities such as compulsively checking the market’s minute-by-minute fluctuations. 

Firstly, she says that as equity markets have trended upwards for the better part of the last decade, it has been easy for investors to let portfolios become progressively equity-heavy.  

"But a key job for investors is to continually assess the riskiness of our asset allocation," she says.  

Instead she invites investors to use the Morningstar portfolio manager and X-ray tools to see how their portfolios are positioned.

Armed with that information, she says you can then compare your holdings against a sensible benchmark, such as Morningstar Australia's five defensive/growth asset class combinations - Conservative, Cautious, Balanced, Growth and Aggressive, available via the Wealth Forecast Engine. 

Secondly, Benz says an investment policy statement is invaluable in keeping an investment plan on track during a downturn. She says that you can tailor yours to suit your needs, but at a minimum, it should: state your investment goals - date, amount, duration, ongoing contribution amounts, basic asset allocation framework, and what qualities you're seeking in your investments.  

Benz says retirees and those approaching retirement should also maintain a separate retirement policy statement that documents their withdrawal-rate system, among other key retirement planning factors. 

Lastly, Benz urges investors to take a closer look at the quality of the investments they've chosen to include in their portfolio.  

"Ask yourself: do my holdings align with the commitments I've identified out in my investment policy statement? Do my holdings receive strong ratings from Morningstar Australia's analyst team – are my managed funds Gold, Silver or Bronze rated?"

 

More from Morningstar

• Property slowdown may cap earnings for building suppliers

• 7 costly myths of sustainable investing

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Emma Rapaport is a reporter with Morningstar Australia, based in Sydney.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.