In volatile times, it is important for clients to remember that smart investing can overcome the power of emotion by focusing on relevant research, accurate data, and proven strategies. Here are seven principles that we believe can help investors during a downturn.
1. Market decline is part of investing
For long periods of time, stocks have tended to rise steadily, but history tells us that a falling stock market is an inevitable part of investing. The good news is that corrections (defined as a 10% or more decline), bear markets (prolonged 20% or more decline) and other complex patches did not last forever. Even the omission of just a few trading days can be affected. Thus, time in the market, rather than time in the market, is a key principle that should be noted.
2. Maintain a long-term perspective
The downturn in the markets may feel as if they last forever when we are in them, but the average bear market is only 13 months compared to the average bull market in 72 months1. No one can accurately predict short-term market movements, and investors sitting on the sidelines run the risk of losing out in periods of significant price increases following the recession.
In fact research2 Held by the Capital Group among British IFAs and retail investors during the pandemic underscores the importance of maintaining a long-term perspective. In light of the blow to customer confidence, 79% of IFAs advised customers to stay invested and avoid time to market. A look back at the rapid recovery of markets after reaching lows in March 2020 is a good illustration of the value of maintaining long term.
3. Emotional investing can be dangerous
Emotional reactions to market events are completely normal. Investors should expect to be nervous when markets decline, but it is the actions taken during such periods that can mean the difference between investment success and deficit.
One way to encourage sound investment decisions is to understand the basics of the behavioral economy. Recognizing bias can help investors identify potential mistakes before they make them.
4. Make a plan and stick to it
Creating and adhering to a well-designed investment plan is another way to avoid short-sighted investment decisions, especially when markets are moving lower. The plan should consider several factors, including risk tolerance and short-term and long-term goals.
When we are going through such volatile times, it is easy to respond by focusing on the short term. But the right thing to do in this environment is to expand your time horizon and think about the long term.
5. Diversification issues
A diversified portfolio does not guarantee a return and does not guarantee that the investment will not decrease in value, but helps reduce risk. By allocating investments across different asset classes, investors can buffer the effects of volatility on their portfolios. Total returns will not reach the highest highs of any individual investment, but they will also not reach the lowest lows.
For investors who want to avoid the stress of recession, diversification can help reduce volatility.
6. Fixed profits can help bring balance
Although bonds may not be able to match the growth potential of stocks, they have often demonstrated resilience in past stock declines. Bond placement can be the basis for a strong and resilient portfolio as it can provide stability in times of uncertainty. Bonds issued or guaranteed by stable governments or corporations with good business models and sound balance sheets can become key building blocks for a capital conservation strategy. Even with the low returns we have experienced over the years, fixed income has fulfilled its role of saving capital.
As inflationary dynamics continue to evolve, it is important not to make short-term decisions when investing in such inflationary periods. Looking back inflation over time, with the exception of periods of extreme inflation or significant deflation, fixed-income markets have brought value in the long run. With a very selective fundamental approach, investors can mitigate higher inflation rates, from investing in inflation-linked bonds to asset classes such as high yields or emerging markets that continue to provide positive real returns and are less affected inflation.
7. The market seeks to reward long-term investors
Is it reasonable to expect 30% profit every year? Of course not. And if stocks have fallen in recent weeks, don’t expect this to be the start of a long-term trend. Behavioral economics tells us that recent events have had a huge impact on our perceptions and decisions.
It is always important to maintain a long-term perspective, but especially when markets are declining. Although stocks rise and fall in the short term, they tend to reward investors for longer periods of time. Naturally, emotions erupt during periods of volatility. Those investors who can turn off the news and focus on their long-term goals are in a better position to develop a smart investment strategy.
1 Sources: Capital Group, RIMES, Standard & Poor’s. As of December 31, 2020, the Bull Market, which began on March 23, 2020, is considered current and is not included in the calculations of the “average bull market”. The periods of the bear market are a reduction of prices from the peak to the minimum in the S&P 500 by 20% and more. Bull markets are all other periods. Returns in US dollars.
2 The survey was conducted from 22 to 28 June 2021 by the independent research agency Opinium among 503 IFAs based in the UK and 1,003 retail investors aged 45 and over with investments worth £ 50,000 and up.