Volatility is back. Just as many were starting to think markets only ever move in one direction, the pendulum has swung the other way. Anxiety is a completely natural response to these events. Acting on those emotions, though, can end up doing us more harm than good.
There are a number of tidy-sounding theories about why markets have become more volatile. Among the issues frequently splashed across newspaper front pages: trade wars, violence from right wing extremists, and rising interest rates.
As to what happens next, no one knows for sure. While others talk about “the growth story” and “tackling the shifts rocking today’s markets”, I am reminded of the seven simple truths of investing:
1. Don’t make presumptions.
Remember that markets are unpredictable and do not always act the way the experts predict they will. When central banks relaxed monetary policy during the crisis of 2008-09, many analysts warned of an inflation breakout. Instead, inflation has remained low.
2. Someone is buying.
Quitting the equity market when prices are falling is like running away from a sale. Another way of viewing the decline in prices is investors have become more concerned about risk and expect to be compensated by higher expected returns. And while the media headlines proclaim “investors are dumping stocks,” remember someone is buying them. Those people are often the long-term investors.
3. Market timing is hard.
Recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was at its worst—the S&P 500 turned and put in seven consecutive months of gains totaling almost 80%. This is not to predict that a similarly vertically shaped recovery is in the cards, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the reward.
4. Never forget the power of diversification.
While equity markets have turned rocky again, high quality short-term fixed income securities have continued to deliver positive returns. This helps limit the damage. So diversification spreads risk and can lessen the bumps in the road.
5. Markets and economies are different things.
The world economy is forever changing, and new forces are replacing old ones. This applies both between and within economies. New economic forces are emerging as global measures of poverty, education, and health improve. Because current market prices incorporate expectations of economic forces, performance of investment markets differs from economic performance.
6. Nothing lasts forever.
Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.
7. Discipline is rewarded.
The market volatility is worrisome, no doubt. The feelings being generated are completely understandable and familiar to those who have seen this before. But through discipline, diversification, and understanding how markets work, the ride can be made bearable. At some point, value re-emerges, risk appetites reawaken, and for those who acknowledged their emotions without acting on them, relief replaces anxiety.
As confirmed by the success of index funds (and the mutual funds described in Investing 3.0: What the Creators of Index Funds Discovered and How to Profit from It), you should maintain the percentage of your portfolio invested in stocks and keep your costs low by avoiding transaction costs.
I’m drafting this message to you Monday evening, October 29 2018, in advance of what may be a wild ride for the a little while. By the time you’re reading this, prices may still be tumbling, or they may already have recovered their footing. We can’t say. (After a similar message on October 10, the market recovered.)
Come what may, I hope we can be helpful to you at this time.
Have current conditions left you troubled, unsure of where you stand? Let’s talk. We’ll explore whether you’re able to sit tight with your existing strategy, or whether we can help you think through any next steps you may be considering. Most of all, know you are not alone! We are here as your sounding board and fiduciary advisor. Your best interests remain our top priority.
Are you reflecting calmly on current events, recognizing that market volatility happens? Allow us to applaud you for your stamina, and remind you: Current conditions likely represent a time for continued quietude, along with ongoing attention to managing your tailored portfolio.
Let’s be in touch if we can answer any questions or scale down the angst you may be experiencing.
If you know others who could benefit from this message, please share it with them and let them know that I’m available to talk.