Back to basics in volatile times

Share investors should expect stock markets to fall one year in every five. In return, the benefit of owning part of a company is generally higher than average returns compared to more defensive asset classes such as cash or fixed interest. In my experience, investors find it easier to stay connected with their long-term objectives in the ‘up’ years but can lose focus during the ‘down’ times.  

1. Down markets are painful, although, over the longer term, markets rise.  

In the past 47 years, there have been eight equity market downturns - defined by a 10% top to bottom stock market fall. The US / China trade war triggered the last downturn in October 2018 and only lasted for around 2 months. By April 2019, the market had recovered. Some declines are more severe than others and last for varying time periods; however overall equity markets rise with time. For instance, a dollar invested in a basket of ‘large company stocks’ in 1973 would have grown to over $108 by 2019 – despite investing through eight downturns. 

2. Risk of stock market loss is lower over longer periods  

During asset allocation discussions with clients, we often say that if a 30% fall in the value of the ‘equity’ portion of a diversified portfolio cannot be tolerated tomorrow, then share investing is not appropriate for the circumstances. Although stock investing is a highly uncertain proposition from year to year, long term gains have been demonstrated to offset short term risk. Research compiled by Morningstar supports this message by showing that since 1926:  

• There have been 94 one-year periods, of which 25 have resulted in a loss.  
• Of the 90 overlapping five-year periods, only 12 have resulted in a loss 
• There have been 80 overlapping 15-year periods, zero have resulted in a loss.  

3. Ineffective market timing has significant impacts  

Holding money back for future investment makes sense if investors believe what they are planning to buy will soon fall and then eventually rise. The problem is that it’s impossible to consistently make forecasts like this. Attempting to time the market exposes investors to the risk of missing periods of excellent returns, therefore negatively affecting their investment outcomes. Additionally, staying focused on a long-term investment plan (rather than market timing) should enable investors to participate in recoveries which often occur very soon after a downturn.  

When it happens, each crisis feels like the worst one yet. Sticking to basic principles as explained above, good quality diversification and a long-term perspective is key to investing success throughout the various market cycles.