Our Top Market Takeaways for February 18, 2022.
Principles of investing
Back to the basics: The case for staying invested (always)
Global markets have had yet another week of ups and downs, with most major indices heading into Friday down on the week. Recently, we’ve pored over inflation, central bank policy, geopolitics, and what they mean for our outlook and portfolio positioning. We’ve acknowledged that those dynamics may keep markets volatile for the foreseeable future.
For most investors, volatility isn’t fun. Investor sentiment has slumped to notably pessimistic levels (the latest AAII Investor Sentiment Survey showed that less than 20% of respondents feel “bullish” right now, the lowest reading in more than five years), so it’s no wonder that we’re hearing more questions about whether it’s time to “get out” of the market, or at least hold onto excess cash until the storm passes.
The short answer: It’s not! In fact, for most long-term investors, it’s probably actually the time to stay (or get) invested. You might view that as a reductive investment cliché, but hear us out.
First things first: Diversification works.
“You should never put all your eggs in one basket.” This is perhaps the golden rule of investing for the long run. The idea is that a diverse portfolio can help mitigate losses in the event of a market downturn.
In 2022’s sell-off, we’ve seen both stocks and core bonds decline, but even just a basic diversified portfolio (comprising 60% MSCI World equities and 40% Global Aggregate Bond Index exposure) has offered protection. At their worst point in January, global stocks were down -8%; the diversified portfolio was down only 75% as much (-6%).
To be clear, a diverse portfolio won’t keep up with one comprising all equities when the stock market is rising. But this concept is all about mitigating the downside. By helping investors avoid the full brunt of market downturns, diversification has historically helped a portfolio’s value recover sooner, and smooths out the ride along the way.
Given that investors are human, and humans are emotional beings, this has more value than you might think.
“It’s no surprise to me I am my own worst enemy.”
DALBAR, a financial services research firm, has made sense of how emotions impact investment decisions by studying the timing of mutual fund flows. Based on that fund flow analysis, DALBAR approximates the return achieved by the “average investor” over a 20-year period. Its conclusion? Most investors are bad at market timing, but try to do it anyway.
Despite strong index returns over time, the “average investor” has underperformed a basic, indexed 60/40 portfolio by 3.5% annualized. On a $100,000 initial investment from the start of 2001 through the end of 2020, that adds up to nearly $170,000 of missed gains!
Timing the market is tough, and missing the mark comes with consequences.
Maybe you think you can time the market better than the aforementioned “average investor,” and maybe you’re right! But consider the risks.
The chart below illustrates what’s happened when an investor missed the 10 single best days in markets over the past 20 years. If missing the 10 best days sounds implausible to you, consider that in the past 20 years, seven of those best days happened within just about two weeks of the 10 worst days.
So next time market volatility feels scary enough to make you second guess your long-term investment strategy, have a good think before you get out of the market. There could be a 70% chance you’ll miss one of the best days.
There’s always something to be worried about.
In 2020, investor worries centered on COVID-19 and the U.S. presidential election. In 2021, it was new variants of COVID-19 and China’s simultaneous property market turmoil and regulatory crackdowns. Today, it’s hot inflation, central bank policy tightening, the Russia/Ukraine conflict…what’s next?
I love the table below, both because it’s helpful in remembering much of what investors have been through, and also because it emphasizes the mantra of “this too shall pass.”
This one isn’t about dismissing prevailing risks; it’s about remembering that markets tend to right themselves as those risks pass. Since the start of 2017, an investment in the S&P 500 has more than doubled up to the present despite all of the concerns that have plagued investors over the years. It’s also worth mentioning that volatile times are when active management and thoughtful portfolio construction can earn their keep by adjusting exposures to better weather the bumps.
The bottom line: Diversification, time in the market and a steady head can help investors achieve their long-term financial goals by avoiding the pitfalls of emotionally driven, badly timed mistakes. When times get tough in markets and make you feel nervous, remember the lessons from tried-and-true investing principles.