Few things are as unsettling to investors as a bear market. Watching your investments move wildly in price can be difficult to stomach. How can you stay true to your long-term plan when the markets are volatile?
In this article, our Teesside financial advisers explain why market fluctuations can be challenging to manage, why emotive decisions can be damaging, and how to stay positive and disciplined when others may be panicking.
Why markets fall
A market is essentially a representation of how millions of investors are feeling about a certain investment (or set of investments) at a given time.
If sentiment moves significantly – either positively or negatively – then the market price will rise or fall. This can happen for many possible reasons.
Perhaps worrying news emerges about the economy (e.g. a poor GDP growth outlook), which leads investors to abandon certain shares and move to “safer” investments, such as bonds.
Maybe a terrorist attack or war declaration causes investors to panic. Sometimes, a narrative “goes viral” across many investors and causes a “herd mentality” effect, leading them to flock to a “hot stock” (or abandon a “doomed” one). The narrative may or may not be true.
Accepting the reality
Unfortunately, it is impossible to forecast market movements consistently. Nobody can predict investor sentiment, the news cycle, and how key players will react to headlines.
This is the nature of the beast when investing. Unlike cash, which remains highly stable over time, equities and other assets (e.g. property and bonds) will fluctuate depending on supply, demand, sentiment, and other factors.
Certain assets may move more than others. In particular, equities are broadly more volatile than bonds. Historically, they have also at times displayed an inverse relationship (when the bonds fall, equities rise simultaneously – and vice versa).
Understanding these investment dynamics is crucial to prepare an investor for the reality of being in the markets. Before committing capital, consider your attitude to investment risk and volatility. How much are you prepared to accept along your investment journey?
Being honest about your “investor profile” will set you on the best possible footing when investment storms inevitably come. A financial adviser can help you discern your profile by asking targeted questions about yourself.
For instance, how would you react if your portfolio fell by 20% tomorrow? If you are confident that you can stay true to your long-term investment plan despite the discomfort, then you may be more suited to a portfolio with a heavier focus on equities.
Conversely, if you know that you would face an overwhelming urge to get out of the markets (to protect from further losses), then a more “cautious” approach might be more suitable – e.g. a portfolio with a greater percentage of bonds.
Remember history
Past performance is no guarantee of future results when it comes to investing. However, taking time to remember previous downturns and market turbulence can help you keep a cool head when your portfolio is rocked by volatility.
A recent example is the 2020 “Covid Crash”. As news of the pandemic spread across the world, investors began realising that huge economic disruption was coming. Markets reacted wildly, with the US Dow Jones Industrial Average Index (DJIA) falling 26% in just four days.
At the time, many investors (including pensioners) fled the markets and crystallised big losses. However, by April 2020, the market was starting to recover. This seemed bewildering to many analysts since the world was in full lockdown. Yet investors were gaining confidence as the Fed and other government entities stepped in to support the global economy.
By November, US markets had returned to their January 2020 levels. By 27th November, the DJIA passed 30,000 for the first time. The S&P 500 was also up 15.6% by the end of the year. Those investors who had fled the market were left nursing considerable wounds. By contrast, many who stayed disciplined got to “ride up” the recovery.
Necessary adjustments
None of this is to say that investors should simply ignore what is happening in the markets. Indeed, occasional rebalancing may be needed to ensure your asset allocation stays on track with your goals, risk tolerance and strategy.
For instance, a big “swing” in equities could cause this asset class to take up a higher (or smaller) percentage of your portfolio value than intended. A financial adviser can help you discern when might be the best time to rebalance everything – and where to target specific sales/purchases.
On this subject, try to avoid checking your portfolio too often. Constantly watching the markets can increase stress and lead to irrational decisions. A better approach might be to set periodic check-ins rather than daily monitoring.
Invitation
We hope this content gave you more clarity. To discuss your own financial plan, please get in touch to arrange a free, no-commitment consultation with an adviser here in Teesside.