Even during disruptive global events and extreme market moves, it’s important to think long term. Otherwise, losses are to be feared.
Right now, our clients are asking us if they should start repositioning their portfolios, changing their asset allocation or even setting price floors. Our advice, as always, is to invest wisely, that is to say by maintaining a long-term vision and by favoring relevant fundamental research, solid data and proven strategies. Impulse investing can be perilous.
1. Stock market corrections are a natural phenomenon
Despite the tendency for stocks to rise steadily over long periods of time, history has shown that stock market corrections are a natural phenomenon. There is good news, however: no correction (dip of 10% or more), no bear market (contraction, over time, of 20% or more) or any other bad period has lasted indefinitely.
Market downturns happen frequently, but they don’t last
When markets falter, some may tend to reduce their equity exposure. History shows, however, that periods of market turmoil and sharp contraction have subsequently proven to be the best times to invest.
2. It’s the length of the investment that counts, not when you invest
No one is able to accurately predict short-term market movements, and investors who sit on the sidelines risk missing out on periods of substantial price increases that follow market contractions.
Every correction of 15% or more in the S&P 500 index between 1929 and 2020 has been followed by a recovery. The average increase during the year following these setbacks was 55%. Missing just a few sessions can be expensive.
3. Impulse investing can be perilous
To be moved by events in the markets is perfectly legitimate. However, while it is normal to worry when the markets fall, it is the decisions made during these periods that can make the difference between success and failure.
One way to support rational investment decisions is to understand the fundamentals of behavioral economics. By recognizing behaviors such as anchoring, confirmation bias and availability bias, investors can identify potential mistakes – before they make them.
4. Make a plan, and stick to it
Carefully crafting an investment plan and sticking to it is another way to avoid short-term decisions, especially when markets are falling. The plan should consider many factors, such as risk tolerance and short- and long-term goals.
When we go through episodes of volatility like this, it is easy to react by focusing on the short term. But in such an environment, the right thing to do is to adapt your investment horizon and see the long term.
5. Diversification matters
A diversified portfolio does not guarantee profits or provide assurance that the value of investments will not decline. On the other hand, it reduces the risk. By spreading their investments across different asset classes, investors can limit the effects of volatility in their portfolios. Overall, the results will not reach the individual highs of each investment, but they will also not fall as much as their lows.
For investors who want to avoid some of the stress of recessionary periods, diversification can help reduce volatility.
6. Bonds can provide some balance
While equities are important components of a diversified portfolio, bonds can provide an essential counterbalance. As they are rather weakly correlated to the equity market, they tend to move in the opposite direction to the latter.
Quality stocks have demonstrated their resilience despite a difficult context
What’s more, bonds with a low correlation to equities can mitigate equity-related losses within an overall portfolio. Funds that offer this diversification can help create long-lasting portfolios, and it’s a good idea to choose bond funds that have demonstrated their ability to generate positive results in different market environments.
Although bonds may not be able to match the growth potential of equities, they have often demonstrated their resilience during previous equity market corrections. For example, US core bonds have risen in four of the last five corrections by at least 12%.
7. The market tends to reward long-term investors
Is it reasonable to expect results of 30% per year? Of course not. Likewise, the decline in equities in recent weeks should not be seen as the start of a long-term trend. According to behavioral finance, recent events disproportionately influence our perceptions and our decisions.
It’s always important to maintain a long-term perspective, especially when markets are falling. While rising and falling in the short term, stocks have tended to reward investors over longer time frames. Thus, over all the rolling 10-year periods between 1937 and 2021, the S&P 500 index generated an average annual return of 10.57% (bearish phases included).
During periods of market volatility, it is natural for emotions to build. However, investors who manage to keep a cool head, ignore the news and stay on course for the long term are better equipped to develop a sound investment strategy.
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