Keeping your nerve when you see minus signs on your portfolio statement is not easy. Throw in a global pandemic, the rising cost of living, interest rate hikes, and a news cycle of war and political division, and it’s little wonder many investors want to exit the market and hunker down until the good times return.
This is a classic case of loss aversion, an emotional reaction that involves investors taking action to avoid a perceived loss. Simply, humans tend to feel the pain of a loss twice as intensely as the joy of an equivalent gain. In a soft market there are more sellers than buyers, pushing prices down, sometimes dramatically. There is, therefore, a natural temptation to run for the hills.
But if you choose to take money out of the market, you’re making two timing decisions: pulling out just before the market plunges and getting back in time to ride the comeback. This is called trying to time the market, and in the same way a broken clock is right twice a day, you might be right occasionally. But doing this consistently is impossible and akin to gambling, with the odds tilted heavily in favour of the house.
Reacting to a sudden drop or a surge in stock prices is a foolish strategy too. Stocks have a habit of deceiving even the savviest investor because a declining market can jump slightly before dropping again, while a rebounding market often hits a few speed bumps.
In many ways, ignorance is bliss – especially if you’re investing for the long term. Remember that bear markets – a drop of 20% or more from recent highs – tend to be short, so you are better off checking your portfolio intermittently rather than monitoring the ups and downs and daily successes and failures. For instance, if you had put all your money into the S&P 500 before spending 2020 disconnected from the internet, you would have logged back on 12 months later to an increase of 16%, without enduring the 32% drop in March.
The truth is: no one has a crystal ball; no one knows what the market will do. Who saw the 2020 COVID-19 induced crash coming? No one, and anyone who says they did should be treated with suspicious. The truth is the cost of trying to predict the future and time the market can be devastating for a portfolio. Those investors who panicked and got out during that March low missed a recovery of epic proportions and the third-best day for the S&P 500 in the past 20 years1. Incidentally, the top two days in this list came straight after the 2008 crash. In moments of sickening market crashes, it’s worth remembering the worst days tend to be followed by the best days.
The Bank of America released a study in 2021, published on CNBC, which showed the importance of staying invested during volatility and not trying to time the markets2. Between 1930 and 2020, staying in the S&P 500 yielded a cumulative return of 17,715% but if you missed the 10 best days per decade, your return would plummet to just 28%. A cocky investor might point to that fact that if you missed the 10 worst days per decade, your return would be over 3 million percent2, but that’s not realistic unless you’re a soothsayer or fortune teller.
Counterintuitively, market volatility is the best time to find value if you have cash (liquidity) ready to deploy into smart investment decisions. So, what should you do to not only avoid a costly emotional reaction but also to maximize the opportunities volatility presents?
1, Have a plan – stay aligned with long-term goals
The first thing is to focus on what you can control. No one can control the markets, but you can control your approach to them by planning for turbulence. This is an important conversation to have with your advisor, who can not only help you prepare mentally for downturns but also understand your risk tolerance, knowing what type of assets, sectors and companies will fit with your long-term plan. Don’t put cash to work with no plan; be opportunistic but be methodical and stay diversified to maintain protection.
2, Invest consistently
Consistent investing – even when markets appear to be in turmoil – is vital. Some of the best times to buy stocks is when things seem to be at their worst, so regular investing gives you the discipline to buy undervalued stocks when they are at their cheapest. With that in mind, consider automatic investments or contributions.
3, Use the experts
Having the knowledge and nerve to take advantage of a downturn requires expertise, which is why your Portfolio Manager can help you take advantage in line with your portfolio and long-term goals. This may involve opportunistic rebalancing, using some losses to reduce future tax bills, or finding undervalued stocks that offer significant future profit potential.
4, Reduce withdrawals
Just ploughing ahead with the 4% rule, for example – a withdrawal strategy that says you can safely take 4% of your total portfolio in the first year of retirement and in subsequent years, adjusted for inflation – may not be the best strategy. Depending on stage of life, an unrealistic first-year withdrawal during a bear market could cripple your portfolio’s potential for long-term growth. The answer is to reduce withdrawals until the market stabilizes.
1 J.P. Morgan Asset Management analysis using data from Bloomberg, courtesy of CNBC.