Increased volatility in the stock market has created anxiety, particularly coming on the heels of a period of relative calm when it was easy to forget that markets go down as well as up.
Although we all know the standard advice to sit tight and wait out turbulent times, doing something feels better than doing nothing, and many yield to the temptation to deviate from their long-term investment plans. For that reason, it is helpful to shore up resolve by remembering the reasons not to react in the moment.
Simple logic helps: selling when markets are “doing poorly” translates into selling after a decline – or selling low – and buying when markets are “doing better” means buying after markets have gone up – or buying high. In other words, instead of selling high and buying low, emotional decision-making in times of volatility leads us to do the exact opposite.
Compounding this damage to the growth of wealth are the effects of missing just a handful of the days when the market performs the best, as shown by the chart below. These few days account for a substantial proportion of the total return of stocks over long periods.
Performance of the S&P 500 Index. 1990-2017
In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best days(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best days(s). Annualized returns for the missed best days(s) were calculated by substituting actual returns for the missed best days(s)with zero. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. One-month US T-Bills is the IA SBBI US 30 Day TR USD, provided by Ibbotson Associates via Morningstar Direct.
Stock markets aggregate and reflect all the available information and expectations of market participants, making it virtually impossible to systematically exploit stock mispricing. Between 2002 and 2016, the majority of mutual fund managers did not beat their benchmarks after costs. Any success in market timing is more likely due to luck than skill, leading to the conclusion that this approach to investing is a form of gambling.
Framing volatility in a broader context is also calming: over the past four decades, the US market has shown intra-year declines – the largest market decrease from peak to trough during that year – of over 10%. However, in spite of these declines, calendar returns were positive in 33 of 39 years.
In reviewing the evidence, attempts to avoid market volatility seem to result in greater uncertainty in the investor experience. Indeed, market timing produces more extreme returns and may expose investors to dramatic shifts in risk profiles over time. Compound returns – an important measure of performance as it equates to the growth of wealth – are quite likely lower as a result. Market timing involves additional trading, which translates into higher costs and possible tax implications.
Of course, there is a fairly straightforward way to avoid market volatility: buy a low interest rate guaranteed investment. However, better long-term returns come with a price: volatility. Investors are compensated for assuming risk. However, exposure to risk should be rational and based on a well-thought out plan and well-balanced portfolio. Capturing what the market has to offer involves maintaining a consistent exposure and staying disciplined.
Remembering that volatility is a normal part of investing helps keep emotions under control, as does the realization that reacting emotionally to a downturn may be more detrimental to the performance of your portfolio than the drawdown itself.
Jason Sirman is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd.