Market cycles -Investing through adversity

In volatile times, it is important for clients to remember that smart investing can overcome the power of emotion by focusing on relevant research, solid data and proven strategies. Here are seven principles we believe can help guide investors during market declines.

  1. Market declines are inevitable

Over long periods of time, stocks have tended to move steadily higher, but history tells us that stock market declines are an inevitable part of investing. The good news is that corrections (defined as a 10% or greater decline), bear markets (an extended 20% or greater decline) and other challenging patches haven’t lasted forever. Even missing out on just a few trading days can take a toll. As such, time in the market instead of timing the market is a key principle to note.

  1. Keep a long-term perspective

Market downturns can feel like they last forever when we’re in them, but the average bear market is only 13 months, compared with the average bull market of 72 months. No one can accurately predict short-term market moves, and investors who sit on the side lines risk losing out on periods of meaningful price appreciation that follow downturns.

In fact, research conducted by Capital Group among UK IFAs and retail investors during the pandemic highlights the importance of maintaining a long-term perspective. In light of the hit to client confidence, 79% of IFAs advised clients to stay invested and avoid timing the market. A look back at the rapid recovery in markets after the lows of March 2020 illustrates the value of a long-term perspective.

  1. Beware emotional investing

Emotional reactions to market events are perfectly normal. Investors should expect to feel nervous when markets decline, but it’s the actions taken during such periods that can mean the difference between investment success and shortfall. One way to encourage rational investment decision making is to understand the fundamentals of behavioural economics. Recognising biases may help investors identify potential mistakes before they make them.

  1. Make a plan and stick to it

Creating and adhering to a thoughtfully constructed investment plan is another way to avoid making short-sighted investment decisions – particularly when markets move lower. The plan should consider several factors, including risk tolerance and short- and long-term goals.

When we go through volatile times like this, it is easy to respond by focusing on the short term. But the right thing to do in this environment is to push your time horizon and think for the long term.

  1. Diversification matters

A diversified portfolio doesn’t guarantee profits or provide assurances that investments won’t decrease in value, but it does help lower risk. By spreading investments across a variety of asset classes, investors can buffer the effects of volatility on their portfolios.

Overall returns won’t reach the highest highs of any single investment – but they won’t hit the lowest lows either. For investors who want to avoid some of the stress of downturns, diversification can help lower volatility.

  1. Fixed income brings balance

Though bonds may not be able to match the growth potential of stocks, they have often shown resilience in past equity declines. An allocation to bonds can be the anchor for a durable and resilient portfolio as it can provide stability in times of uncertainty.

Bonds issued or guaranteed by stable governments, or corporations with good business models and solid balance sheets, can be key building blocks for a capital preservation strategy. Even in the low-yield environment we have been experiencing for years now, fixed income has fulfilled its role of preserving capital.

As inflationary dynamics continue to unfold, it is important not to take short-term decisions while investing in these kinds of inflationary periods. If we look at inflation over time, excluding periods of extreme inflation or significant deflation, fixed income markets have delivered value over the long term.

With a highly selective fundamental based approach, there are ways for investors to mitigate higher inflation, ranging from investing in inflation-linked bonds to asset classes such as high yield or emerging markets, which offer still positive real yields and are less affected by inflation.

  1. Long-termism is rewarded

Is it reasonable to expect 30% returns every year? Of course not. And if stocks have moved lower in recent weeks, you shouldn’t expect that to be the start of a long-term trend either. Behavioural economics tells us recent events carry an outsized influence on our decisions. It’s always important to maintain a long-term perspective, but especially when markets are declining.

Although stocks rise and fall in the short term, they’ve tended to reward investors over longer periods of time. It’s natural for emotions to bubble up during periods of volatility. Those investors who can tune out the news and focus on their long-term goals are better positioned to plot out a wise investment strategy

Chris Miles Head of UK financial intermediaries, Capital Group

See also: Staying the course amid uncertainty in Europe

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