With talks of a recession on the horizon, rising interest rates and the stock market in decline it is easy to lose perspective and become emotionally motivated when making financial decisions. However, extensive research throughout history has shown the benefits of remaining invested especially during market downturns. The following article will discuss the advantages this approach can provide investors and how to remain focused on the bigger picture during economic turmoil and market decline.
What does this strategy look like?
Staying invested also known as the ‘buy and hold’ strategy is about maintaining your current position and holding onto your individual investments as opposed to selling them during uncertain market conditions. If the thought of this fills you with dread, this may be a good opportunity to revise your allocation to riskier investments. Ensuring that you are comfortable with your risk profile and evaluating your exposure to growth and defensive assets can reduce the chances of you making the wrong decisions during market volatility as the kinds of assets you are invested in align with your risk tolerance.
What are the benefits?
Research conducted by Vanguard has found that ‘being out of the stock market for just the best 30 trading days since 1928 (almost a century) would have resulted in half the return over that period,’ and because it is almost impossible to pick when these days will occur, it is important to stay invested.
Difficulty of timing the market
Although it is natural to want to avoid seeing the value of your investments fall, trying to perfectly time when you will leave and re-enter the market is highly difficult and most likely going to result in investors missing out on the returns they could have received had they remained invested. Investors can look at previous market performance and trends to understand the future economic outlook, however, different factors are responsible for varying degrees of market downturn including the pandemic, politics, monetary and fiscal policy, business activities and international events. Thus, it is often the best approach for investors to stay the course throughout these events and wait for markets to recover.
Buying or selling due to particular changes in the market or on the basis of a stock performing in a particular way is akin to gambling as individual performance is almost impossible for the average investor to predict. Therefore, if you have left the market due to a downturn and the value of your holdings rebound, you will have missed out on the opportunity for them to recover in value and potentially generate returns.
The graph below shows the difference between ‘time in the market’ and how missing significant trading days can impact the returns of investors as they have missed these key opportunities for growth.
Long-term returns
The longer an investor stays invested, the less likely they will experience negative turns and the likelihood of a negative return for a balanced portfolio has historically been very low. Research from Russell Investments has suggested that a balanced portfolio of both equities and bonds has not produced a negative return over any five-year period rolling since 1979. Although past performance is not necessarily indicative of future performance, investors can find comfort in the fact that markets are cyclical and often follow particular economic trends. Therefore, staying invested will help to reduce the chances of negative performance as investors are not selling their investments at a loss and instead allowing their portfolios to recover and benefit from market growth.
Volatility allows for opportunities
Market volatility and downturn enables investors to place themselves in a better position to take advantage of future market returns. As the market value of particular holdings fall during market downturn investors are able to purchase more shares in a particular stock or company at a cheaper price. This means that once the company’s value rises again in the future, they can benefit from the returns generated as a result of purchasing during market downturn. The dollar cost averaging strategy also works in favour of investors during market volatility as it lowers the average buy-in price and therefore helps to boost returns over the long-term. To read more about this strategy, click here.
The bottom line for investors is to maintain a diverse portfolio that takes advantage of market volatility and the importance of rebalancing your assets without constantly diving in and out of the market. If you have been unsuccessfully trying to time the market and are looking for a reliable strategy that you can understand and trust, please click here to organise a complimentary meeting with an EPG Wealth adviser.