With the negative, attention grabbing headlines inundating the mainstream media of late, it is easy to revert to a pessimistic and distorted view of markets and outlook for your personal investment portfolio. One would be forgiven for believing the world was going to end, after just a few moments spent reading some of the recent financial news headlines. Understanding the inherent conflict of interest between media outlets and successful lifetime investors is increasingly important. This article illustrates the normality of temporary market declines, the questions all investors should consider and what you can do to combat those instinctively irrational thought processes.
Market turbulence – strap in, it’s going to be a bumpy ride
Volatility is not just a recent phenomenon. We have been through a period of low market volatility in recent times. This has in fact been out of the ordinary, but it is easy to become accustomed to recent market conditions, overweight them and consider them to be the new ‘normal’. This common cognitive bias is better known as ‘recency bias’, which can have a damaging effect on wealth creation if not understood and addressed appropriately.
Source: Carl Richards (Behaviour Gap, 2018)
Unfortunately, as human beings, we are hard wired to ignore our rational thought processes and focus in on – and become emotional about – adjustments to share prices. The influential investor, Benjamin Graham, was famously quoted saying ‘in the short term, the stock market is like a voting machine. In the long run, it is a weighing machine’. Understanding how capital markets function is of paramount importance, to avoid acting irrationally in times like these.
Timing the market – questions you need to ask yourself
Our instinctive reaction as investors is often to react to market news or short term volatility. However, the academic evidence overwhelmingly suggests that trying to time the market is a sure-fire way to wealth destruction over time. Remember that your globally diversified portfolio has been proactively constructed to weather all market storms and the current market turbulence is just part of that long-term plan.
Nevertheless, investors often see short-term volatility as the enemy. This may lead many to move their money out of the market until things perceivably ‘calm down’ or the market ‘picks back up’ again. This approach may appear to solve one problem, but it actually creates quite a few more. Firstly, when do you get back in? You must make two correct decisions back-to-back; when to get out and when to get back in. By sitting on the side-lines, you may be missing a potential rebound. Not only that, you may be missing out on all of the potential compounded growth on that money going forward.
The chart below illustrates this point by using a popular domestic index representing the 100 largest companies listed on the London Stock Exchange – the FTSE100. We can see that volatility is commonplace. In fact, the average intra-year decline in the FTSE100 between 1984 and 2017 was approximately 15%. However, the average calendar year return was 7% over the same period. (For illustrative purposes only; a 7% compounded return would represent a doubling of starting capital every 10 years.) As you can see, those investors who chose to stay in the market were rewarded for their patience with a positive calendar year more often than not and in every single period the calendar year return was higher than the respective intra-year decline.
Data source: Financial Express Analytics Software (FE Analytics, 2018)
This chart is for illustrative purposes only and not indicative of any actual investment. Past performance is no guarantee of future results.
Unwavering faith in capitalism – a prosperous economic model
It is easy to become accustomed to and underweight the amazing progress global societies have made over the past century. Let’s remind ourselves of the remarkable, persistent and robust wealth creation of global capitalism. Although in extremis, capitalism can be divisive, cruel and abused, it is a remarkable economic system that has delivered astounding results, in terms of innovation, reduction of global poverty, as well as increased human longevity and birth rates. Despite all the doom and gloom peddled by market commentators, wealth creation is remarkably robust over time (see UK GDP growth below). This is good news for disciplined, long term equity investors, as they are part owners in the great companies of the world which continue to innovate and contribute to long term global economic growth.
Data source: Office for National Statistics (ONS, 2018).
Helping ourselves – keeping our emotions in check
If you can’t help yourself from being concerned, perhaps work your way through the following mental checklist when markets fall:
- Do you need access to the money invested today, or even in the next 5 years?
- Is this short-term market fall a surprise to you?
- Has capitalism ceased to be a driver of global growth and wealth creation?
- Is the global economy shrinking?
- Is it a good thing to sell equities when they have fallen?
- Do you think that the market will be below where it is today in 10 years’ time?
- Do ordinary patterns of returns warrant extraordinary actions?
If the answer to most of these questions is ‘no’, then try to stop worrying.
Try not to look too often at the value of your portfolio, stop listening to the hyperbole of the mainstream media and stop dwelling on the news. Yet, do be optimistic about the power of the wealth creation potential of global capitalism over the time frame you will be invested.
The wise course of action is to review your unique financial plan and decide if any action is indeed necessary. This placates the natural desire to ‘do something’, but helps keep emotions in check.
One of the most effective traits of successful lifetime investors is discipline. Short term market volatility is nothing unexpected – it’s all part of the long-term plan. Stick to the program.
Written by Sam Holmes (Financial Planner)
If you would like to speak to a qualified Financial Planner about this, or any other matter, please give us a call today on 01275 370670. We would love to hear from you.
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This article has been published for educational purposes only and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.