Turbulent markets are inevitable and those who are able to ride out a sell-off tend to end up better off, says Pete Brooks.
Turbulent markets are one of the greatest, and also the most unavoidable, threats to every investor’s portfolio.
When the markets wobble, you often see the nerves of those invested do the same, with many people taking the view that it’s better to cut their losses early rather than hang around and see what happens. The result? A market sell-off.
We’ve seen this a number of times over the past year alone, with global political tensions bubbling to the surface. In February, we saw what was termed a “market correction” and, since October, there has been a broad retreat across stock markets, with technology companies at the epicentre.
Some investors seem to take this in their stride and see opportunities when markets are falling. Others are more prone to panicking, which can lead to hasty decisions that are not in their long-term financial interests.
Irrespective of emotional reaction, however, investors who are able to ride out a market sell-off tend to end up better off. This is simply because rather than crystallising the losses that they have endured, they hold on until markets recover.
So, what lessons can investors use to hold their nerve in the face of volatility? Below, we suggest five rules to help handle a dip in the market.
1) Stay disciplined and patient
It goes without saying that the self-disciplined tend to be more successful in most, if not all, aspects of life. The self-disciplined do not allow their choices to be dictated by their impulses. Instead, they make informed, rational decisions without taking things personally.
2) Pre-commit to an investment plan
If you aren’t naturally sanguine, a disciplined and patient approach to investing may be more difficult. One of the best ways to tackle this is to commit to a series of future decisions that then take place by default. This overcomes any lack of discipline during turbulent markets. Since you have committed to doing something, you can make more thoughtfully planned decisions when markets are calmer.
3) Make regular contributions
With regular investment contributions, you pre-commit to adding to your portfolio each month and market conditions don’t come into the decision. In some months, the markets will be doing well and in some months, they won’t. More importantly, this disciplined approach lowers any temptation to try and pick the bottom of a turbulent market.
4) Keep the correct perspective of time horizon
Volatility and short-term losses are inevitable and you have to live with them. Many of us have long-term financial goals, yet we often assess our progress towards them over short horizons. The more frequently you monitor your portfolio, the more risk you will perceive and this sense of danger can lead investors to try and time markets by chopping and changing portfolios. Looking less often can help investors keep longer-term goals in mind.
5) It’s only a loss if you sell
A loss on your computer screen is not a real loss until you press the sell button. While it is tough to leave your portfolio alone as it falls in value, the reality is that – unless the investments you have made have gone bust (and this is extremely rare) – they may go back up again over time. By leaving them alone and not selling out, you are not incurring any real losses at what might be the worst point in time to sell.
Pete Brooks, head of behavioural finance, Barclays Smart Investor.