Each of these events on their own could be regarded as groundbreaking. But when they arrive largely at the same time, they represent a tectonic shift in the established global financial order.
In short, the world is living in incredibly disruptive times – politically, economically and socially. And this disruptive environment is proving to be fertile ground for financial market volatility.
For investors, this can make for an uncomfortable ride. And for many, especially millennials, it could be their first such experience of an uncomfortable ride.
Long-term investment managers like Capital Group believe that one of the most important things to do during this type of volatility may also be one of the hardest – to contain emotion. It’s never easy to do so when markets are on the way up, and it isn’t when they are on the way down. Purely in an emotional sense, market volatility can create doubt in some, panic in others, and anxiety for nearly all. But during periods of volatility, containing emotion is vital to creating wealth over time.
Right now, many investors around the world are asking the same question – “Should we start to reposition our portfolios, change our asset allocation or look for a bottom in prices?”
In this environment, we believe the best approach is to focus on active investing – while keeping a long-term investment horizon and focus on bottom-up, fundamental research to thoroughly analyse companies and assess their ESG risks and opportunities. This can help with making informed investment decisions.
Emotional investing can be hazardous, so investors might keep these seven principles in mind.
1. Market declines are part of investing
Over long periods of time, stocks have tended to move steadily higher, but history tells us that stock market declines are an inevitable part of investing. The good news is that corrections (defined as a 10% or more decline), bear markets (an extended 20% or more decline) and other challenging patches haven’t lasted forever.
Market downturns happen frequently but don’t last forever
When markets falter, some investors may be inclined to reduce their exposure to equities, yet history shows that periods of turmoil and steep market declines have subsequently been proven the best times to invest.
The message: Stay invested.
2. Time in the market matters, not market timing
No one can accurately predict short-term market moves, and investors who sit on the sidelines risk losing out on periods of meaningful price appreciation that follow downturns.
Every S&P 500 decline of 15 per cent or more, from 1929 through 2020, has been followed by a recovery. The average return in the first year after each of these declines was 55 per cent.
Even missing out on just a few trading days can take a toll.
3. Emotional investing can be hazardous
Emotional reactions to market events are perfectly normal. Investors should expect to feel nervous when markets decline, but it’s the actions taken during such periods that can mean the difference between investment success and investment pain.
One way to encourage rational investment decision-making is to understand the fundamentals of behavioural economics. Recognizing behaviours like anchoring, confirmation bias and availability bias may help investors identify potential mistakes before they make them.
4. Make a plan and stick to it
Creating and adhering to a thoughtfully constructed investment plan is another way to avoid making shortsighted investment decisions — particularly when markets move lower. The plan should consider several factors, including risk tolerance, and short and long-term goals.
When investors experience volatile times, it is easy to respond by focusing on the short term. But we believe the right thing to do in this environment is to push your time horizon and think for the long term.
5. Diversification matters
A diversified portfolio doesn’t guarantee profits or provide assurances that investments won’t decrease in value, but it does help lower risk. By spreading investments across a variety of asset classes, investors can buffer the effects of volatility on their portfolios. Overall returns won’t reach the highest highs of any single investment — but they won’t hit the lowest lows either.
For investors who want to avoid some of the stress of downturns, diversification can help lower volatility.
6. Fixed income can help bring balance
Stocks are important building blocks of a diversified portfolio, but bonds can provide an essential counterbalance. That’s because bonds typically have low correlation to the stock market, meaning that they have tended to zig when the stock market zagged.
High-quality bonds have shown resilience when stock markets are unsettled
What’s more, bonds with a low equity correlation can potentially help soften the impact of stock market losses on your overall portfolio. Funds providing this diversification can help create durable portfolios, and investors should seek bond funds with strong track records of positive returns through a variety of markets.
Though bonds may not be able to match the growth potential of stocks, they have often shown resilience in past equity declines. For example, U.S. core bonds were positive in four of the last five corrections of 12 per cent or more.
7. The market tends to reward long-term investors
Is it reasonable to expect 30 per cent returns every year? Of course not. And if stocks have moved lower in recent weeks, investors shouldn’t expect that to be the start of a long-term trend either. Behavioural economics tells us recent events carry an outsized influence on our perceptions and decisions.
It’s always important to maintain a long-term perspective, but especially when markets are declining. Although stocks rise and fall in the short term, they’ve tended to reward investors over longer periods of time. Even including downturns, the S&P 500’s average annual return over all 10-year periods from 1937 to 2021 was 10.57 per cent.
It’s natural for emotions to bubble up during periods of volatility. Those investors who can tune out the news and focus on their long-term goals are better positioned to plot out a wise investment strategy.
Matt Reynolds, Investment Director, Capital Group (Australia)
