The stockmarket is a rollercoaster ride: hang on!

If you can’t handle a 10 per cent drop, you shouldn’t be in the stockmarket.

Bulls and bears: the stockmarket deals with both animals

Let’s assume you are a normal investor in what has suddenly become a far from normal market where inside a week the returns for the year have turned negative.

We have just seen the fastest correction since 1980.

This is not “buy the dip” territory, and neither is it a “get out at all costs” market. Rather, it is a test of nerve. And let’s define what we mean by “normal” here using a major survey the Vanguard group carries out among 16,000 private investors each year.

You don’t trade more than 10 per cent of your portfolio in any year. To localise this survey, we will also assume that franked dividend income matters more than it does to professional investors.

But you are no slouch, no wide-eyed innocent believing the market is an easy ride and your investments are only part of a wider diversified portfolio.

You know the last 14 months have been too good to be true, as former prime minister Paul Keating put it this week (when lobbying to get industry funds to finance small business), and investors have been on a risky “joyride” as markets rushed higher.

But here’s the thing: unlike those fund managers strapped to quarterly returns, you don’t have to sell. What’s more, if things get worse, interest rates will fall again — rate cuts support sharemarkets. Remember the faster markets drop, the faster they recover. So what’s the outlook?

In a note written after the correction got under way this week, a top asset allocation consultant — Damien Hennessy of Heuristic Investment Systems — put it this way: “On the one hand, evidence that the virus has spread outside of China adds to downside risk. More widespread business closures and restricted people movement would undermine spending and confidence.

“On the other hand, the likelihood of a stronger recovery in later 2020 is also possible as policy is eased further, and pent-up demand is unleashed.”

For the vast majority of private investors the sharemarket is the money maker — you know it’s money at risk but it has been very good for a very long time, broadly since March 2009.

Last year sharemarket investors pulled in more than 20 per cent over 12 months.

Sure, that was exceptional. But if you want evidence of how sharemarket investors win in the end, Credit Suisse this week released a report that said Australian stocks have offered an annualised real return of 6.8 per cent a year since 1900. Credit ­Suisse also made the point that our market is also exceptionally stable — using a standard deviation measure, the bank says we are the second-lowest-risk market in the world (after Canada).

So, in that light, let’s assess a very bad week. Yes there has been a scare and it was always going to happen — our market was the fastest-rising market in the world, beating all rivals in January.

We’re already close to a 10 per cent correction — that hurts, but any long-term investors should handle that.

ETFs to feel the pinch

Perhaps no group of investors will perceive this drop more acutely than those who have recently moved into the market through exchange traded funds, which aim to do no more than reflect market indices.

The Morningstar research group reported this week that 2019 finished with the amount of money moving into ETFs in Australia totalling $61bn — that’s a staggering 52 per cent jump on the year before. The issue now is that these investors are strapped in tight to the wider direction of the market: the ETF brigade will certainly have lost all gains they made this year in recent days.

If you are a more diversified investor with a customised range of individual stocks you may have done better or worse. This is going to be a very rocky few months and stock picking is going to come back into fashion.

This correction will give passive investors a shake and prompt a potential rebound for all active managers, and value managers in particular.

At the start of the year — before we put on 7.7 per cent on the ASX and just as quickly lost it — the majority of major brokers were forecasting an ASX 200 sitting at 7000 by the end of 2020. (Last year we closed at 6684.)

We are now close to 6400: those 12-month predictions looked bearish at the time, now they look entirely reasonable.

That’s share investing. If you are serious, you stay in. If you can’t handle a 10 per cent drop, perhaps you should not be in the sharemarket at all.

Warren Buffett, the world’s greatest sharemarket investor, should have the last word.

Just a week ago he said in his annual shareholders letter: “Occasionally, there will be major drops in the market, perhaps of 50 per cent magnitude or even greater. But the combination of The American Tailwind and compounding wonders will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!”