Keeping calm during turbulent times
PERIODS of market volatility, like we've seen recently, will be unsettling times for most investors. The risks of incurring losses can make holding investments difficult to bear, with the temptation being to sell out and cut your losses. This may put a stop to the anxiety you may (temporarily) be feeling, but may harm your longer term investing goals.
Sudden market moves can be testing times for all investors because we get a stark reminder of what investment risk really feels like. Short-term volatility, whilst unpleasant, should not detract your focus from the long-term objectives for which you have (hopefully) made your investments.
Your focus should be on ensuring that the inevitable bumps along your investment journey do not force you off course. When markets are falling and it seems like everybody is selling, staying invested can seem daunting and dangerous. Equally, when markets are rising and everybody seems to be buying, keeping a level head and ignoring the crowd can be difficult.
We often highlight the role of a diversified portfolio in managing investment risk but it also has a big role in helping investors manage their reactions to markets. A well diversified portfolio should shield you from the full brunt of sharp falls in a particular market, but will also mean that the moves in your portfolio are more muted than attention grabbing headlines may lead you to believe. Every day you have the option to buy, sell or stay invested. A well diversified portfolio can make it easier to take the decision to stay invested rather than follow market moves.
For those investors with cash to invest the recent market moves may create opportunity. No investment strategist has the crystal ball to tell you whether you are buying at the bottom of any dip or the top of any peak. As markets have fallen, the best you can know is that you aren't at the top. The short-term ride may continue to be bumpy, but for those with the composure to get invested, the prospect of not buying at the very top of a market would boost longer term returns.
Anyone who has had the discomfort of chicken pox will know that the medical advice not to scratch the itchiness doesn't remove the temptation. Investing behaviour is similar – understanding that your reactions to markets can be dangerous to your wealth doesn't make it any easier to leave your portfolio alone. Giving into temptation can feel comforting and boost our sense of having control.
However, in investing we often see that action for actions sake proves more harmful than the status quo. Research in Behavioural Finance finds that the more frequently we trade the more we reduce our financial returns on average, not only because of the costs of trading but also because we react very differently to gains and losses.
If investors feel the urge to act, the small changes which come from rebalancing a portfolio can be one way to take control of the situation. At a time of stress this embeds the good behaviour of selling a bit of whatever has performed best in your portfolio and buying whatever has performed less well – exactly aligned to buy low and sell high behaviour.
Time and time again we see that over long enough time periods markets do recover from downturns, although past performance is no indicator of future performance.
Corrections can be healthy, and result in even stronger growth in the future, although this is not guaranteed and could get back less than you invest. This is why holding a diversified portfolio for the long-term makes good investing sense. It is time invested in the market, and not the timing of the market, which will dictate long term returns.
:: Jonathan Sloan (firstname.lastname@example.org) is a private banker at Barclays Wealth & Investment Management