This week we sit down with Arnerich Massena consultant Corrie Oliva, CFA, for a discussion about long-term investing and the importance of maintaining perspective during periods of market volatility. After a period of relative calm, the past six months have seen a return of volatility, and we want to provide investors with the right tools to invest wisely while maintaining peace of mind.
Arnerich Massena: Can you start by telling us what some investors tend to do during periods of volatility?
Corrie: Fear is a strong emotion, particularly when it comes to investing. There is a great tendency to react precipitously and sell asset classes that are losing value. This is a natural reaction, but this may be the worst time to sell. After selling the asset class that is declining, these same investors will often move to asset classes that are perceived as safer. In March of this year, for example, there was a large influx into taxable bonds, widely seen as a safer investment than equities.
AM: What should investors be doing instead?
Corrie: I recommend that everyone – individuals and institutions alike – have a clear investment plan or policy statement. A thoughtful investment strategy that takes into account unique characteristics such as time horizon and risk tolerance can take the emotion out of investing, so that decisions are based on a long-term outlook instead of short-term market movements.
While an investment plan or policy will vary depending on the investor’s objectives, I typically recommend three things. First: diversify across asset classes. Diversification is very important in helping to mitigate market volatility, reduce risk, and increase long-term compound returns. Second: stay invested per the strategy you’ve laid out, and don’t move your money in and of the market when things fluctuate. It is extremely hard to time the market to miss downturns and take advantage of upturns. For example, Figure 1 below shows performance for the S&P 500 Index during the first quarter of 2016. During this short period, a number of investors sold their stocks during the downturn in late January and early February, but then missed the subsequent recovery! Third: rebalance your portfolio according to your policy.
Click on image to see larger version.
AM: Why shouldn’t an investor pull money out to help weather a downturn?
Corrie: If you had a crystal ball and could see the peaks and troughs of the market in advance, that would be a great strategy. But without a crystal ball, it’s really hard (if not downright impossible) to predict market movements down to the day, week, or even month. And if you try to do so, you’re likely to miss some of the market’s best days, which can have a significant negative impact on your portfolio. Figure 2 below shows the effects of missing 10, 20, 30, 40, 50, or 60 of the best days of the S&P 500 over a 20-year period. So, create a long-term strategy, make sure that the strategy doesn’t exceed your tolerance for risk, and stay invested.
Click on image to view larger version
Source: JP Morgan
This chart is for illustrative purposes only and does not represent the performance of any investment or group of investments. 20-year annualized returns are based on the S&P 500 Total Return Index. Past performance is not indicative of future results.
AM: Is it true that you actually advise people to buy some investments when they are losing value?
Corrie: Yes, sometimes. This is part of my third recommendation: rebalance your portfolio as needed. An investment plan should include target percentages for the asset classes. As these different asset classes outperform or underperform, you’ll need to rebalance your portfolio back to its original targets. For example, if you’ve set a target of 40% equities and equities lose 10%, then your portfolio will be underinvested in equities. And it is a great time to buy when the prices are relatively low. Buy low, sell high.
AM: Do you have any final advice to offer?
Corrie: I’d caution investors away from chasing returns. In other words, just because an investment has been great doesn’t mean it will continue to be great. A far better strategy is to create a diversified portfolio that doesn’t exceed your tolerance for risk and outlines a plan for strategic rebalancing and disciplined investing. Lastly, I’d suggest that you consult with an investment advisor; they can help with all of these challenges and more.