Get Invested, Stay Invested
Introduction
In this technology and media driven era, it can be difficult to stay focused on long term investment objectives with all the noise of short-term volatility in the markets. The most effective approach to reaching investment goals is to remain calm during market swings and to have a disciplined, mapped out course of action.
The age-old investment saying of time in the market, not timing the market has never been more relevant than in the current environment.
Market volatility should be something investors look to minimize, but it should not scare them. Volatility is perfectly normal throughout investment cycles and can even provide buying opportunities in oversold markets.
WEATHERING THE STORM - “A SMOOTH SEA NEVER MADE A SKILLED SAILOR”
There are various degrees of market volatility that investors should be aware of and look to manage. Understanding your risk tolerance and risk capacity are important drivers in choosing an asset allocation. An investor’s risk tolerance refers to their aversion to risk, while an investor’s risk capacity relates to their ability to assume risk.
Like the open ocean, there is always movement in markets, and with movement in markets comes volatility. Degrees of volatility can range from small ripples, to rolling waves, to a financial crisis tidal wave. It could be very tempting to react to these swings in markets, but this report will explain how discipline must be maintained throughout your investment time horizon. Investing through a diversified portfolio with a long-time horizon is the best way to batten down the hatches during volatile markets and avoiding knee jerk reactions like selling at the market bottom.
The importance of staying invested
Predicting when the best time to enter or exit the market is extremely difficult. Most retail investors, and even professionals, get this timing wrong. High frequency trading and algorithms have made it next to impossible for investors to match the speed at which markets react to news and other factors that result in volatility. Often times, when large dips in the markets occur, buying opportunities are seized by institutional investors and markets turn fairly quickly, before retail investors have the chance to take advantage.
When investors try to time their entry and exit, they may actually get stuck selling out at a bottom and miss this bounce back into positive territory. Chart 1 below illustrates a portfolio of $10,000 invested in the S&P 500 in 1996 and what the return would look like if a stretch of the “best” days were missed through 2016.
THE SOBERING LESSON:
If an investor missed the 10 best trading days of the 5,052 trading days from January 2, 1997 – December 31, 2016, returns could be cut in half (see above chart 1 and right chart 2).
Volatility is normal, stay disciplined
Even in years with normal to strong equity returns, there are still rolling waves of volatility (see blow chart 3). That being said, it is perfectly normal to feel uneasy about market pullbacks resulting in a lower portfolio value in the short term. It is important not to react to these pullbacks and to keep in mind that volatility is common and to be expected. In the long run, discipline breeds success. The below chart 4 shows how investors can limit their downside risk by having a long term, disciplined investment approach
Navigating Volatility
Drown out the noise – Market movements are notoriously difficult to predict. In the world of “fake news”, the media outlets that scream the loudest are not always the most accurate. Once news hits the public domain, it is already too late to react in equity markets for the retail investor.
Look, but don’t stare – While it is important and encouraged for investors to keep an eye on their investment accounts, short-term market swings can be quite volatile and spur emotionally driven decisions. The likelihood of realizing a loss from a temporary market pullback decreases significantly the longer your time horizon is (see chart 4 above). Periodic review of investments is necessary, but investors should tune out short-term swings and focus on their long-term investment objectives.
Batten down the hatches – It is important for investors to take the time and proper advice to determine a diversified, sound investment plan based on their specific goals and risk tolerances. Discipline to stick to the plan is imperative to achieving these goals.
