Imagine you’re on a long-haul flight and the pilot informs you of every hint of turbulence. It would drive every passenger crazy. Thankfully, instead, most of us watch a movie, grab some uncomfortable sleep, and wait until the plane’s wheels hit tarmac. Ignorance is bliss.
Yet, when it comes to the financial markets, investors absorb daily blow-by-blow accounts of price drops, stock bubbles, and geopolitical-induced volatility. This can influence decisions and emotions, and lead to panic selling – and often panic buying – that harms your portfolio.
For example, if you had put all your money into the S&P 500 before spending 2020 in a cave, you would have emerged, blinking, to an increase of 16%, thank you very much. You would also have saved yourself the emotional turmoil of watching the index sink 32% in March.
For those investors that ran for the hills and exited the market at its bottom, they missed a recovery of epic proportions and the third-best day for the S&P 500 in the past 20 years1. Incidentally, the top two days in this list came straight after the 2008 crash. The morale of the story: the worst days tend to be followed by the best days.
To illustrate this further over a longer timeframe, according to J.P. Morgan analysis, had someone invested $10,000 in the S&P 500 on January 1, 2002, and stayed the course through December 31, 2021, they would have a balance of $61,685. However, if they missed the market’s 10 best days during that time, they would have only $28,260.
Time in the market beats trying to time the market, and for long-term investors, staying the course is paramount to meeting your goals. Your trusted advisor can guide you, but it helps everyone’s heartrate if you also understand the highs and lows of the market.
A lot of people associate volatility with a dishevelled, shellshocked Lehman Brothers employee but, in plain terms, it’s simply a measure of how much the stock market’s overall value – or that of a single stock – fluctuates up and down. Standard deviation is the statistical measure commonly used to represent volatility.
In a lot of cases, corrections – significant market drops – are healthy and reset valuations and investor expectations. There may be value in buying during these dips, with the help of a professional, in order to gain in the long run, but the most important thing is to stay invested. We are all, however, human, and make mistakes.
Studies into behavioural finance focus on the fact investors are not always rational, have limits to their self-control, and are influenced by their own biases. In short, we mess up. Far from a fault, it’s actually perfectly normal. It takes an exceptional person to think differently, like Michael Burry of The Big Short fame, or Warren Buffett. But even the best fall into these traps.
Buffett, revered by many, believes investing success doesn’t correlate with IQ after you’re above a score of 25. “Once you have ordinary intelligence, then what you need is the temperament to control urges that get others into trouble,” he says.
Investors, typically, think they know more than they do, interpret information incorrectly, make decisions based on emotions, and are influenced by others. Common biases include confirmation bias, a tendency to accept information that confirms an already-held belief, and loss aversion, which often results in people selling their winners and hanging onto to losers. In other words, investors are quicker to recognize gains then losses.
Other behavioural mistakes include familiarity bias and recency bias; most investors are guilty of getting attached to a certain stock because they know about it, while in the immediate aftermath of 2008, the view of the market was so dismal many exited thinking, wrongly, that another crash was inevitable.
Essentially, then, to err is to be human. Mistakes are inevitable, and this can help create market bubbles and accentuate recessions, but it also informs our reactions to market turbulence. Whether it’s panic selling to the detriment of our portfolio, hanging on to a losing stock too long, or following the herd in buying a ton of GameStop because it’s trendy, how an investor controls these impulses can determine whether they reach their long-term financial goals.
How to stay invested
A retirement investment plan should not be a thrill ride like a night at the casino (set aside some play money for that). Overcoming biases and avoiding knee-jerk decisions requires logical and methodical thinking, not gut-instinct. Staying invested, therefore, requires a plan. Here are some pointers:
Ride out the volatility
Whether the market is “surging” or “plunging”, the sign of a good investor is their ability to stick to their long-term plan. Past results are no guarantee of future returns, of course, and Q1 2022 was a healthy reminder of that, but individuals have rarely lost money in the S&P 500 over a 20-year period.
Don’t try to time the market
Whether it’s meme stocks, tech start-ups, or waiting for the optimum time to re-enter the market, unless you have a crystal ball, don’t bother. Even the likes of Buffett have no interest in this because it’s virtually impossible to successfully do time and time again. As a result, many investors miss rebounds that can make or break yearly returns. Also, never forget that the markets are five steps ahead of the headlines, so whatever you’re thinking is likely already priced in.
Know your risk tolerance
Your trusted advisor will be able to tailor your financial plan according to your appetite for risk and stage of life. A young professional with decades of their career ahead of them will require a different plan compared to a soon-to-be retiree. Plus, some people innately are more conservative with their money. Get your exposure to risk assets wrong and the chance of panic-selling or poor decision-making increases.
In a well-rounded portfolio, growth opportunities in equities have ballast through fixed income and alternatives which will help keep those biases in check.
Plan for market turbulence
This is an important conversation to have with your advisor. Volatility will happen (and humans often make it worse) so be prepared mentally for some alarming headlines and value changes. If you are a more aggressive investor, you might be comfortable putting money to work during the dips. Don’t splurge indiscriminately, however – know what type of assets, sectors, and companies you want and make sure it fits with your long-term plan. Be opportunistic but be methodical.
Systematic portfolio reviews
Another way in which your advisor can help. Annual or semi-annual reviews guard against portfolio drift, where the retirement plan is not updated to changes in life circumstances, risk appetite, or market conditions. Take the rising interest-rate environment and the fact certain stocks react differently to this. An investor’s portfolio should account for this, and regular meetings with your advisor will provide a chance to discuss and agree on the path ahead.
As boxer Mike Tyson famously said: “Everyone has a plan until they get punched in the mouth”. It’s the same with investors when the market crashes. But unlike being in the ring with Iron Mike, investors can absorb the “blows” and stay on their feet.
With a sound financial plan, the help of your trusted independent advisor, and an understanding of the human condition, disciplined investors can successfully reach their retirement goals without stressing over daily or weekly market turbulence. Select your airplane movie, get comfortable and let your financial plan do the rest.