Even during disruptive global events and extreme market fluctuations, it is important to think long term. Otherwise, you should be afraid of losses.
Right now, our clients are asking us if they should start repositioning their portfolios, change their asset allocation, or even set floor prices. Our advice, as always, is to invest wisely, i.e. keeping a long-term vision and prioritizing relevant fundamental research, hard data and proven strategies. Impulse investing can be dangerous.
1. Stock Market Corrections Are Natural
Despite stocks trending steadily higher for long periods of time, history has shown that stock market corrections are a natural occurrence. The good news, however, is that neither a correction (a 10% or more drop), nor a bear market (a 20% or more decline over time) or any other bad period lasted indefinitely.
Market downturns happen often, but they don’t last long.
When markets fluctuate, some may be inclined to cut back on their stock holdings. However, history shows that periods of market turmoil and slump have subsequently proved to be the best time to invest.
2. Duration of investment matters, not when you invest
No one can accurately predict short-term market movements, and investors who sit on the sidelines risk missing out on periods of significant price growth that follow market cuts.
Every S&P 500 correction of 15% or more between 1929 and 2020 has been accompanied by a recovery. The average growth during the year following these failures was 55%. Skipping just a few sessions can be costly.
3. Impulse investing can be dangerous.
It is perfectly legitimate to be touched by events in the markets. However, while it is normal to worry when markets are down, it is the decisions made during these periods that can make the difference between success and failure.
One way to support sound investment decisions is to understand the fundamentals of behavioral economics. By recognizing behaviors such as anchoring, confirmation bias, and availability bias, investors can identify potential errors before they make them.
4. Make a plan and stick to it
Developing an investment plan carefully and sticking to it is another way to avoid short-term decisions, especially when markets are down. The plan should take into account many factors such as risk tolerance and short and long term goals.
When we go through episodes of volatility like this, it’s easy to react by focusing on the short term. But in such an environment, it will be right to change your investment horizon and look at the long term.
5. Diversification Matters
A diversified portfolio does not guarantee a profit and does not guarantee that the value of an investment will not fall. On the other hand, it reduces the risk. By spreading their investments across different asset classes, investors can limit the impact of volatility on their portfolios. In general, the results will not reach the individual highs of each investment, but will not fall as much as their lows.
For investors who want to avoid some of the stress of periods of recession, diversification can help reduce volatility.
6. Bonds can provide some balance
While stocks are important components of a diversified portfolio, bonds can provide a significant counterweight. Since they are rather weakly correlated with the stock market, they tend to move in the opposite direction of the latter.
Quality stocks show resilience despite difficult conditions
Moreover, bonds with a low correlation with stocks can mitigate stock-related losses across the entire portfolio. Funds that offer this diversification can help build long-term portfolios, and it is recommended to choose bond funds that have demonstrated their ability to generate positive results in a variety of market conditions.
While bonds may not match the upside potential of equities, they have often demonstrated their resilience during previous stock market corrections. For example, major US bonds rose in four of the last five corrections by at least 12%.
7. The market tends to reward long-term investors
Is it reasonable to expect results of 30% per year? Of course not. Likewise, the decline in stocks in recent weeks should not be seen as the start of a long-term trend. According to behavioral finance, recent events disproportionately influence our perceptions and our decisions.
It is always important to keep a long-term perspective, especially when the markets are down. While stocks rise and fall in the short term, they tend to reward investors in the long term. Thus, for all rolling 10-year periods from 1937 to 2021, the S&P 500 has generated an average annual return of 10.57% (including bear phases).
During periods of market volatility, it is natural for emotions to escalate. However, investors who manage to keep their cool, ignore the news, and stay on course for the long term are better equipped to develop a sound investment strategy.