There is always a degree of volatility on investment markets. But there are times when world events raise the level of worry and uncertainty, causing markets to seesaw, sometimes violently, from one day to the next.
As investors, this sort of activity doesn’t put us in our happy place. A slow and steady upward climb is what we’d all like to see.
As regular listeners and readers of my weekly email GainingCHOICE have heard me observe many times before, volatility is the price we must pay to achieve the returns that are so generous from stock market investment. You can leave your savings in the bank and get half a percent if you’re lucky, which means your savings would double in about 144 years. Or you could invest in the stock market where you’re highly likely to get a return of 8% plus over a 7 to 10 year timeframe, resulting in your money doubling in around nine years. Certainly for me, that’s a pretty easy choice to make. But that doesn’t mean it’s not uncomfortable during volatile times.
So this week let’s take a look at some investing fundamentals and how they apply during periods of heightened volatility. I’m hoping they help dial back any anxiety you are currently feeling about your investments.
Why are you investing?
A great starting point when working through periods of stock market volatility is to reflect back on why you are investing in the first place. What are your goals? Does this period of volatility in any way alter your goals? In almost all cases, the answer is no. Whether you’ve got a retirement goal, something around lifestyle, buying that house by the beach, or something else, likely global ructions will have no bearing on your goals.
Your investment strategy has been created to enable you to achieve these goals. If your goals remain the same, then it stands to reason that so too should your strategy.
DCA & RSP
Many strategies will include dollar cost averaging and regular savings plans. The purpose of these investment mechanisms is to progressively add your savings into the investment market. They serve two purposes, one being converting your surplus income into wealth creating assets, but the other important element for our purposes here is that they average the price that you purchase your investments. If you buy $1000 worth of an investment in month one at $100 per unit, and then a month later buy another $1000 worth at $110 per unit, then your average entry price sits in the middle at $105. If however the next month the market falls such that you can buy your next $1000 worth for $90 per unit, well now you’re average price becomes $100. And if the next month the market falls further such that you can buy units at $80 per unit, your average price becomes $95.
I know that sometimes numbers get lost in a podcast but the point to take away is that continuing with your regular investments during periods where markets are down reduces the average price that you have acquired your investments for, which then helps deliver profit and gains in the future as markets recover and resume their standard upward trajectory.
Sometimes during periods of volatility people are tempted to pause their regular investment additions. This is a very bad idea for the reasons mentioned above. Buying during periods of weakness helps enormously in producing attractive returns on your portfolio over time. Picking up some bargains for a few months is an opportunity that doesn’t arise all that often so it’s important that when it’s on the table, you take it.
Buyer vs Seller
Consistent with the importance of maintaining your regular investments, keep in mind the difference between being a buyer and a seller. Buyers want to pay the lowest possible price, sellers want to sell for the highest possible price. If you’re a buyer, which most listeners to this podcast will be, then low prices are what you are seeking. And typically low prices can be found during periods of turmoil and volatility.
Now if you’re retired and living off your investments, then perhaps you are a seller. Sellers of course do not want to be forced to accept low prices during unfavourable times. Sellers therefore should have in place reserves such as term deposits that they can live off during times when selling their shares would deliver poor prices. For people living off their investments, it’s also a good time to reflect on the income producing attributes of the investments that they hold. Investments, be they stocks or property, generate returns through the combination of income and capital appreciation. As a general rule capital appreciation is preferred over income due to the more favourable tax treatment that it receives, however for someone living off their investments, particularly during times of volatility, investment income can be extremely useful in giving them the funds they need to live without the need to sell anything. This points to the potential need for some portfolio changes when you reach this phase in your life.
Rely on the fund’s investment strategy
Most listeners will have their savings invested in a fund. Probably the bulk of your money is in some sort of passive index fund. Some funds may have an active overlay of some sort whether that’s at the asset allocation level or down at the stock picking level. Irrespective of the strategy, you’ve chosen these investment funds because they make sense as a long term strategy to build your wealth. That being the case, global gyrations shouldn’t invalidate the applicability of the strategy. Let’s say you’re in a high growth strategy which will likely have almost all of its assets in stocks. During periods of volatility, your fund manager won’t be selling down a whole lot of stocks and swinging to cash. To do so would not be true to label and not deliver on what investors had purchased the fund to do. Now there are some active funds where managers may try and add value by increasing their cash holdings during volatile times, but given most data suggests that after fees, active managers rarely outperform the index, it’s certainly questionable as to whether such measures are worthwhile. As with us nonprofessional investors, fund managers face the challenge of not only getting the exit timing right but also getting the re-entry timing right. The chances of succeeding at both are slim indeed.
I’ll wrap up by highlighting some often referenced research done out of the United States by a company called Dalbar. Over a long period of time, they have monitored the average return produced by actual investors, compared to the return delivered by the market. The difference between the two reflects individual behaviour. The market return is what you would have received had you simply left your money alone and invested. But of course, all too many investors can’t help but fiddle. In their last reading which ran until the end of 2019, relying on 20 years of data, they found that the average investor underperformed the market by 1.8%. That is the cost of investors trying to get out when markets are volatile and get back in when conditions look positive. Such activity not only doesn’t help protect or grow your wealth, it actually hurts you.
In summary then, if you’re feeling a little uncomfortable during this current market volatility, you’re not alone, and you’re not wrong. You’re just human. But do try and fight the urge to change your investments. If your goals remain the same, then your strategy should remain the same. Visualise every chart of the stock market you’ve ever seen. They all go up and to the right. It’s been happening for well over 100 years and there’s no reason to think that’s going to change anytime soon.
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