Recent market declines have tested investor confidence. While certain discomfort resulting from choppy navigation is a natural reaction, jumping from a sturdy ship would be foolish. Like other media services, financial media is subject to ratings, and sensationalism drives ratings. Below we discuss in detail four well-weathered points to keep in mind and stay on course:
- Unpredictability of markets and media frenzy
- Futility of market timing
- Sticking to your plan and rewards of staying invested
- Importance of diversification and engaging your advisor
Markets are unpredictable and do not always react the way experts predict they will. If so-called experts have such insight and conviction that the market is not fairly priced, why don’t they short the market instead of merely “trimming a bit here or there?” Better to follow Chesterton’s advice: “I agree with the realistic Irishman who said he preferred to prophesy after the event.”
Price declines means that prices have been discounted to reflect higher risk which also means expected returns are higher. Headlines claiming investors are dumping stocks are false. When someone sells, someone has to buy, and often it is long-term disciplined investors. Market timing doesn’t work and can turn unrealized losses into real losses. Recoveries can be as sudden as declines. Investing requires discipline and patience: why pay for risk if will not be there for the reward?
When Apollo 13 informed Houston they had a problem, most at Mission Control panicked, but not Director Gene Kranz who said: “this will be our finest hour,” which led to a turn of events. What went unnoticed is that there was nothing in the solution that the team didn’t already have, except the focus to work through the crisis. Corrections present us with an opportunity to ask the following questions:
- Have my objectives changed?
- Has my investment horizon changed?
- Was my portfolio poorly diversified?
If the answer is no, then there is no reason to abort the mission. Focus on salvaging it by avoiding knee-jerk reactions that will result in unintended consequences such as permanent impairment of capital. This does not mean the task is easy since doing nothing can seem almost naive and foolish. Meet with your advisor and see if there are opportunities to rebalancing or diversify, but otherwise stay the course. Staying invested rewarded clients during the crisis in 2008-2009. Investors that went to cash locked in losses and did not experience rewards.
Bonds have historically offset stock risk and help preserve capital. When equity markets decline, high quality bonds tend to do well, so your advisor will look at your fixed income portfolio and determine if it’s needed to increase quality. Diversification is the key, but ensure there is true diversification vs. naive diversification. Yield chasing usually results in poor diversification and unintended consequences. Evaluate portfolios to determine if “navigating near icebergs.”
In US dollars indices are not available for direct investment. Their performance does not reflect the expenses associated with the management an actual portfolio. Past performance is not a guarantee of future results. Performance data for January 1970 - August 2008 provided by CRSP; performance data for September 2008 - December 2014 provided by Bloomberg S&P data provided by Standard & Poor’s Index Services Group. US bonds and bids data ® Stocks, Bonds, Bids, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).
You need a coach and guide to help navigate the storm of emotions associated with Market Cycles and avoid overreacting. Investors that had a plan and stuck to it usually fared better than investors that merely reacted to events. You need the objectivity, experience, and even-keel of your trusted advisor most when anxiety is setting-in.
With the help of your advisor, focus on what you can control:
- Create an investment policy to fit your needs and risk tolerance
- Structure a portfolio around true drivers of expected returns
- Diversify broadly
- Reduce expenses and turnover
- Set realistic expectations
- Stick to your plan