Recent market volatility has had investors nervously watching their portfolios, perhaps wondering if it’s time to cut their losses.
It’s natural to wonder whether you are doing the right thing with your investments when this happens but, generally speaking, it is usually best to stay invested for the long term rather than attempt to time the markets to avoid financial losses.
Here are four reassuring reasons why, in good times and in bad, staying invested and riding out the storm is usually the best course of action.
1. Money is an emotive subject, but emotions shouldn’t drive investment decisions
Money is the tool that we use to achieve many of our goals and create the life that we want for ourselves and our families. That’s why it can be an emotive subject, as we all have hopes and dreams that we need money to fulfil.
There’s nothing wrong with having big dreams and experiencing a range of emotions when it comes to growing your wealth and planning your future. But if the negative emotions like fear or panic start to drive your investment decisions, this is where you could run into difficulty.
It’s important to understand exactly how investment cycles can make us feel, because this is how you can learn to regulate your emotions and make sensible financial decisions even when things feel worrying.
The diagram below shows how different points in an investment cycle could make you feel.
Source: Yahoo Finance
Notice that, when the value of investments falls, this is often linked to negative emotions like panic, which could translate into feeling as though you should sell your assets to avoid further losses.
But if you can reframe this point in the markets, you’ll see that it coincides with lower costs of buying more shares or fund units. Rather than being a time for fear, you could see it as a time of great opportunity.
This is just one way that understanding the emotions linked to money can help you to make sensible investment decisions. This is called “behavioural finance”, and there are a range of cognitive biases like this one that can affect how you approach your investment portfolio.
Loss aversion
Many investors are more concerned with avoiding a loss than making a gain, which can lead to lower returns overtime if this is the sole focus of your strategy.
Confirmation bias
This is the tendency to seek out or place excessive emphasis on information that confirms something that you already believe to be true, such as the opportunity for a particular fund or stock to increase in value. It can lead to you discounting opposing points of view or being overwhelmed when something unexpected occurs.
Hindsight bias
This bias causes you to believe that good events were predictable whereas bad events were not. In reality, volatility is an inevitable part of investing and should be expected as part and parcel of investing in the stock market.
2. Bull markets tend to outperform bear markets
A bear market is when an individual stock or stock index drops in value by 20% or more from a recent high, whereas a bull market is when markets rise by 20% or more from the most recent bear market.
Bear markets tend to be triggered by slowing economic growth, rising unemployment, and the subsequent wariness of investors in the stock market. By contrast, bull markets usually create a sense of prosperity and confidence in the future alongside high employment rates and economic growth.
While bear markets can be worrying for investors, you might find it reassuring to know that bull markets are far more frequent and tend to last much longer than bear markets.
Forbes Advisor reports that the returns made during bull markets usually exceed the losses experienced during bear markets. Additionally, Vanguard has found that, since 1945, the FTSE All-Share Index has spent 64.7 years in bull market conditions versus just 11.3 years in bear markets.
So, when you look to history, it makes financial sense to feel optimistic about the future, even while you’re going through tough times.
Understanding this as well as the emotional responses to market volatility should help you to regulate your emotions and make more sensible financial decisions because you aren’t responding out of fear.
3. Strategies for timing the market are fundamentally flawed
Despite the research about market cycles, some people might try to time the market in an attempt to mitigate the risk of losses by removing funds when markets drop at least 10%, then reinvesting only when the markets lift by 10% or more.
The theory behind this is that you can miss the worst days in the market and still capitalise when the markets bounce back. It’s a risky strategy, and one that is discouraged by many financial planners because it puts your long-term returns at huge risk.
The reason this method is so risky is because it’s impossible to miss all of the worst days in the market without also missing the best days.
For example, as Forbes reports: 9 out of the best 10 days since 2002 happened during the financial crisis of 2008/9 or during the very first days of the Covid-19 pandemic in 2020. If you had moved your money out of the stock market when those events began, you could have missed huge jumps in value that could have recovered any losses you made initially.
Missing those 10 best days in the market means that your investments generate much lower returns than they would have done otherwise, potentially making it more difficult to reach your long-term financial goals.
4. Compound returns benefit you most over the long term
Another reason for investing in the stock market for a long period of time is the power of compounding, or compound returns.
Compounding is the process of generating returns on the entire value of your portfolio. When this happens over many years or even decades, the growth of your portfolio benefits. This is why you will often hear that investing needs to be for the long term, because compounding works best when the funds are left to grow instead of being constantly moved around.
This makes the consequences of missing the best days in the market even more significant. Imagine how much your portfolio could grow if you allowed it to experience those significant jumps in value immediately after a period of uncertainty? And how much might you miss out if you had accidentally missed those days through attempting to time the market?
Sadly, there are no shortcuts when it comes to growing your wealth. Anyone who promises that they can help you do that is most likely planning to use methods that have been disproved through many years of research and observation of the stock markets.
Get in touch
If you’d like to understand more about how to achieve your financial goals using your investment portfolio, we can help. Either contact your financial planner directly, email us at hello@ascentawealth.com or fill in our online contact form to organise a meeting and we’ll get in touch.
