For the last two years, our market has been flat, delivering barely positive returns. Many investors feel the pressure during times like these, often asking their advisers: “What should I do now?”
The problem is that these flat returns have also been accompanied by heightened volatility, meaning investors have not been rewarded for the risk they have taken over the last two years.
But this immediate default to panic when major local or global events have an adverse impact on the market, is often disproportionate. Big ticket events seem to remove all the certainty from our world. We forget that we have been rewarded with steady inflation-beating returns over the long term, and our focus reduces to the problem we are faced with right now: “What should I do now?”
Action must be justified and measured
When weighing a change in your portfolio, consider the implications and alternatives, and make sure the move you eventually make is right for your objectives, investment horizon and risk profile.
Sometimes, making changes to your portfolio is the right decision, like if your portfolio wasn’t correctly positioned to begin with, or if you have a change in circumstances. Even in volatile times, careful action is sometimes the right call. After all, volatile markets can also present us with buying opportunities. Those with cash on hand often find the best bargains when fear stalks the market.
When action leads to tears
What many people mean when they ask us what they should do, though, is not “Should I review my long-term investment plan?” Rather, what they are really asking, is whether it is time to sell their shares, and rather invest in cash. When we raise the issue of cash not outperforming inflation in the long run, the response is “I’ll invest when the market recovers.” Typically, “What should I do?” is code for “Can I time the market?”
Behavioural economics teaches us that people suffer disproportionately from a loss. This is called loss aversion. The stress caused by such a loss is much more unpleasant than the ‘high’ offered by gains. When people sell out of markets after they have fallen, they are rationally trying to manage their loss aversion. Unfortunately, loss aversion is a poor pilot of your investment strategy.
Research shows that trying to time the market does not work. Markets are not only driven by information and fundamentals, but also by sentiment, which tends to feed on itself. In a bear market, we focus on the negative. In a bull market, bad news is often disregarded.
Research by Dalbar found that equity investors who sold their shares during market volatility in 2011 lost more than 5% of their portfolio values, while investors who remained invested on average made a gain of 2.12% over the same period. If we consider stock market returns up to the end of April 2017, the local stock market outperformed inflation and money markets during the 2008 financial crisis and subsequent two years of recovery.
By the time investors decide to disinvest, the worst may already be behind us. They also tend to miss out on the rebound – because by the time signs of a market recovery are clear, you have already missed out on the start of the run.