After a decade long bull market, October was the most volatile month since the 2008 financial crisis. Thanks in part to political and economic uncertainty; it may have been a wake-up call for more complacent investors.
Volatility of some level should always be expected. But, nobody can truly predict the future, especially regarding financial markets. We wouldn’t place much trust in anybody who claims they could. However, some circumstances are more likely than others.
A market correction, where prices fall 10% or more in any given year, is actually highly likely to happen. Exactly how severe it will be, or when it’s likely to occur, is speculation too far. What’s the best course of action to take? Counter intuitively, in most circumstances, none.
Don’t look down
Not looking at your portfolio’s negative performance could be the key to tackling it. However, there are two significant assumptions in that statement;
1. You are savings towards a long-term ambition, like retirement
2. Your portfolio was appropriate to your circumstances, aspirations and risk tolerance in the first place
Psychology can play a big role in investing; making a rash decision can be more damaging to your financial security than doing nothing at all. Avoiding short-term noise is imperative, patience and discipline could literally pay dividends. After all, you only crystallise a loss when you sell.
Warren Buffett has addressed this subject on a number of occasions: “Benign neglect, bordering on sloth, remains the hallmark of our investment process.” And: “I never have an opinion about the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.” Who are we to disagree?
Ultimately, markets fall and recover, history demonstrates that. Fixating on a temporary situation might only encourage irrational behaviour. If you check a portfolio on a monthly basis, you’ll observe a number of declines over the year. If you check annually or biannually, you’ll see less. Again, we must re-emphasise our assumptions; you need an appropriate portfolio to begin with, a long-term objective and, ideally, an experienced financial planner to hand.
The graph below from JP Morgan demonstrates just how normal volatility is. The red dot indicates the largest intra-year market decline (the fall from peak to trough during the calendar year), whilst the grey bar shows overall return. Evidentially, within a year, it’s quite likely you will experience a significant decline and a positive return. Look at 2009, for example; a 23% intra-year decline and an overall calendar-year return of 25%.
Sensationalist tabloid headlines such as those seen prior to Christmas don’t help you make rational decisions, that’s somewhat of a given. What’s more disconcerting is well-intended regulation causing the same concern.
Under the requirements of MIFID II legislation, discretionary fund managers or financial planners with discretionary permissions have to notify you, almost immediately, if the overall value of your portfolio drops by 10% between the start and end of a calendar quarter. As the graph above shows, a 10% decline within any given calendar year is well within reasonable circumstances. In fact, over the 32 years of data you will have, in theory, been notified of a 10% decline 25 times if the fall occurred within a quarterly reporting period, rather than bridging one. Without reassurance, you could hastily react to this news. Our fear is that some investors could be inclined to withdraw funds at the worst possible time, without appreciating that such falls are in fact relatively normal and are usually followed by a bounce in the market reversing any over-corrections.
Timing the market?
You may have heard the saying before; ‘time in the market, not timing the market’. It holds true; we know volatility is both difficult to predict and inevitable. Remaining invested for the long term, by which we mean five years or more, is by far the most sensible and often profitable way of dealing with market declines. Out of the market, sat in cash, inflation will be eroding buying power. Then, there is no guarantee that when you decide to buy back in it’s the right time. It could be a long, unprofitable, game of second-guessing the situation.
Naturally, if you timed the market accurately and consistently over an extended period, you would be better off. But, frankly, that is impossible. Previous research has even demonstrated that even an individual with consistently poor timing would be substantially better off than if they held cash over the same timescale.
Your original long-term objective should remain the focus of your financial plan. Think of it as following a map; the destination remains the same no matter the distractions along the journey.
Embrace a downturn
Warren Buffett also explained that the worst environment for a long-term investor is a surging market. “The best thing that can happen from [our] standpoint… over time is to have markets that go down a tremendous amount. We are going to be buyers of things over time. And if you’re going to be buyers of groceries over time, you like grocery prices to go down.” So, during volatility, units are cheaper; your regular contributions will be buying a greater number. Over time they will benefit from future gains and compound growth.
If you’d like to discuss your portfolio’s performance or your best course of action to take during volatility, don’t hesitate to get in touch. Our team of Chartered financial planners are here to help you preserve and grow your wealth, at a level of investment risk you are comfortable with.
Marc has worked as an independent financial adviser for over 30 years, advising private clients and businesses on all aspects of their financial requirements. Marc takes a holistic approach to financial planning and actively uses cash flow to help clients understand their financial position in the context of their long-term goals.