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Market Volatility – The Importance of Staying Invested

Badger Investment Group - Feb 01, 2022
Investing is one of the best ways to build long-term wealth, translating the financial objectives you develop with your financial advisor into real world outcomes like a child’s education, your retirement, a house purchase or more.
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Investing is one of the best ways to build long-term wealth, translating the financial objectives you develop with your financial advisor into real world outcomes like a child’s education, your retirement, a house purchase or more.

The ride towards these objectives is not straightforward or always comfortable, as markets often act irrationally and are subject to short-term volatility. The best way to weather these challenges is to develop a financial plan and stick to it, allowing you to build the wealth required to reach your financial goals.

Most investors end up earning less what the market returns over the long term because they make mistakes. The following five mistakes are the most common and costly for investors:

  • Emotional decision-making
  • Recency bias
  • Failure to define risk
  • Trying to time the market
  • Insufficient diversification

 

We have organized this report into sections that address these mistakes, hoping to show with actual market data why it is beneficial for investors to stick to their financial plan, thereby increasing the chances of reaching their financial objectives.

The ideal strategy for an investor is to sell out of the market before it declines and reinvest just as it begins to recover. Of course, this strategy is nearly impossible to execute in reality. How do you know when to sell and when to buy? There’s an old Wall Street saying: “Nobody rings a bell at the top of the market and nobody rings one at the bottom.”

After a sharp decline in the market, many investors naturally want to sell to avoid the potential for further drops in their equity portfolio. Not only does that lock in your losses, but it also raises the question of when to reinvest. Historically, there have been no indicators that have consistently predicted the direction of the market. Even the economy is not a reliable predictor, because the stock market often rebounds months before an economic recovery is evident.

Furthermore, when the market does recover, its gains often come in bursts. Missing those few days or months of strong returns can have a huge impact, as shown in the table. For example, an investor who stayed invested in the Canadian stock market over the entire 30 years ending December 31, 2019 would have had an average annual return of 7.7%. Missing just the 10 best days would have reduced that return to 5.5%, while missing the 25 best days would have resulted in a return of 3.4%. In other words, staying invested can be the best strategy.

We know it is difficult to watch your portfolio and the markets decline in value and think it is a good think, but some investors do. Over the pandemic, BIG has defensive instruments within the model. Given the stock market’s long-term rising trend, market declines have been an opportunity for long-term investors to buy stocks at lower prices. It’s as if stocks are on sale. This is the thinking behind this statement by Warren Buffet, one of the world’s greatest investors: “Be fearful when others are greedy and be greedy when others are fearful.”

Of course, not everyone has billions of dollars in cash like Warren Buffet. But there are tried and true strategies that anyone can use to take advantage of market volatility: dollar cost averaging and rebalancing. Over the coming weeks, we will be looking at capitalizing on market volatility using these techniques.

In general, rebalancing ensures that your portfolio remains true to your risk profile, smooths out your returns, and is a disciplined way to make sure you are “selling high and buying low.”

Investing & Emotions

Investor sentiment can swing wildly based on headlines, and it is not uncommon to see investors making irrational financial decisions during periods when they should see past the negative headlines. Emotion-based decisions lead to buying high and selling low as markets trend steadily higher over the long term, investors tend to redeem at the low of the downturns and purchase at the top when the market recovers.

Emotions make investors conceive that their decisions are rational, prompting them to buy at near highs due to fear of losing out on gains and sell near lows due to fear of further losses. In general, investor sentiment can be considered a contrarian pattern.

The longer the investment horizon, the more likely the investor will be able to weather market challenging periods; staying invested throughout crisis and market downturns helped investors to quickly recover and earn strong returns during the subsequent periods.

Investors can help avoid reactions to market headlines by sticking to investment basics, seeking opportunities to buy when others sell, and working with a financial professional.

Lessons From Downturns

Within the past 15 years, we’ve had few market corrections: the Global Financial Crisis (2007 –2009), the rates normalization fear (Q4 2018 -not a full correction) and the coronavirus pandemic (Q1 2020).

Historically, the market has always bounced back after each downturn and reached new highs.

The lessons we learned from the previous market corrections:

  • No one can predict consistently when market declines will happen.
  • No one can predict how long a decline will last.
  • No one can consistently predict the right time to get in or out of the market.
  • To get through these downturns, investors should avoid panic and focus on the long term.

Volatility is Normal

While market volatility is never pleasant, it is important for investors to accept that market pullbacks are a normal part of investing. For example, the CBOE Volatility Index –or VIX –spikes every few years in reaction to some market events, but the overall trend is for equity values to quickly recover and continue the upward progression.

When markets become volatile, it's not uncommon for investors to be tempted to sell and wait for the tide to turn. But that can be a mistake: when they sell and stay out of the market, investors eventually face the difficult question of when to buy back in again, and those who miss the turn –even for a short period –can cause lasting damage to the value of a portfolio, because market rallies often come in surges that are measured in days not weeks.

During volatile market times, it’s crucial to maintain patience, discipline and to stay invested. The benefit of staying invested over a long-term period is established by the relationship between volatility and time: investments held for longer periods tend to exhibit lower volatility than those held for shorter periods. Rolling returns over longer periods exhibit lower volatility and less exposure to negative returns.

Investors can weather the market challenges by sitting down with an advisor to build a strategic asset mix that matches their risk tolerance and investment horizon. Different assets classes offer different levels of volatility and returns. Investors should hold the optimal mix that matches their risk profile that helps them achieve their long-term objectives.

Timing the Market is Difficult

When markets become volatile, it's not uncommon for investors to be tempted to sell and wait for the tide to turn. But that can be a mistake: when they sell and stay out of the market, investors eventually face the difficult question of when to buy back in again, and those who miss the turn –even for a short period –can cause lasting damage to the value of a portfolio, because market rallies often come in surges that are measured in days, not weeks; investor returns are generally lower than what the market offered over the long term, because of the temptation of market timing.

Timing the market is an impossible strategy: the best days and worst days happen in clustered periods and if these up days are missed, investors will need longer period to recoup their losses.

The benefit of staying invested over a long-term period is upheld by the relationship between volatility and time: investments held for longer periods tend to exhibit lower volatility than those held for shorter periods. The longer you invest, the more likely you will be able to weather low market periods; staying invested throughout crisis and market downturns helped investors to quickly recover and earn strong returns during the subsequent periods.

Investors can weather the market challenges by sitting down with an advisor to build an asset mix that matches their risk tolerance and investment horizon.

Investing for the Long Term

Investing is not typically a get-rich-quick tactic that someone can do for a short period of time and expect to make a significant amount of money. It is a long-term process that requires patience, commitment, and with the discipline to stay calm when the market fluctuates, as it inevitably will. The market tends to gain significantly over the long term because average bull market periods last a lot longer and produce much bigger returns than the average bear market.

One of the greatest aspects of long-term investing is that it allows investors to take advantage of compounding: earning return on principal, past returns, reinvested dividends and interest make the value of the investment grow at an accelerated rate.

Historical Recessions, Crises & Bear Markets

Since 1945, market expansions have lasted longer (8.5 years on average) than market downturns (1 year on average) and have more than made up for the periodic market decline. The best strategy is to commit and stay invested over a long-term period to capture the market upside fully. Timing the market exposes investors to missing most of market rallies over the long term.

The Case for Diversification

Because winning stocks and sectors generally rotate, the optimal solution for investors to protect their portfolios and mitigate the unsystematic risk is to broadly diversify. Historical data demonstrates that diversification helps in achieving consistent returns over time and reducing the overall investment risk.

Contact a Financial Advisor Today

If you would like to have a further discussion on any of the above material or would like to review your portfolio with a Financial Advisor, book a meeting with us today.

CANACCORD GENUITY WEALTH MANAGEMENT IS A DIVISION OF CANACCORD GENUITY CORP., MEMBER-CANADIAN INVESTOR PROTECTION FUND AND THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA This document is for general information only, not intended to provide tax, legal or financial advice, and under no circumstances should be interpreted as a solicitation to act as a securities broker or dealer in any jurisdiction. All views are intended for general circulation only and do not have any regard to the specific investment objectives, financial situation or general needs of any particular person, organization or institution. All investors should consult with a qualified investment advisor or tax professional before making any investment decisions. Tax & Estate advice offered through Canaccord Genuity Wealth and Estate Planning Services.