Between the pandemic, inflation, and Russia/Ukraine, market uncertainty reigns these days. No doubt, some investors are asking themselves: should I take money out of the market now, and get back in when the picture becomes clearer?
This is an understandable reaction. Behavioural psychologists often talk about “loss aversion” or “negativity bias”. Both conditions explain that investors tend to experience loss more intensely than they experience gains. Many people are familiar with FOMO (the fear of missing out) on gains from some hot investment — the fear of losing is just as real.
Can you see the future?
Of course, no one knows what markets will do.
Moving money based on what you think will happen – “timing the market” – is something nobody in the history of investing has consistently done successfully. When you choose to exit the market, in effect you need to make two correct timing calls: predicting the market high (when you get out), and the market low (when you get back in). History shows it’s hard to get one of these decisions “right”. Being correct on the timing of both is even harder.
Counting the cost
There’s plenty of research to show how costly “getting it wrong” is…
A February 2021 analysis from Brompton Funds, a Canadian investment fund firm, found that someone who stayed invested in the S&P 500 through the course of 2020 – including the bear market caused by the pandemic – saw an 18.4% return for the year. Missing the market’s best day cost more than 10 percentage points. Missing the two best days turned their 2020 return into a -1% return.
Unfortunately, the days in 2020 with the best returns happened in March, the same month when market fear was at its highest and many investors had already run for the hills.
How to stay invested
Let’s be clear: it’s a mistake to exit the market, even when it’s rough going. The question should not be whether you are invested but how you are invested, which depends on an individual’s stage of life and risk tolerance.
For example, let’s say you’re a young investor in your mid-twenties. You’ve got decades before you retire, and are working on goals like travelling, getting married, getting your kids through school, owning a home, building a nest egg, and maybe even leaving a legacy. For you, wealth accumulation is a top priority, and time is on your side. Historically, the stock market has been up far more than it has been down. You also still have a lot of earning potential and ability to recover from any dips in the market. You can afford to be bold and invest a bigger chunk of your investable portfolio in equities.
However, if you are retired, you may be more focused on preserving what you have as you don’t have the parachute of time or a working salary. That doesn’t mean you exit the market at the first sign of trouble. Instead, you may benefit from being more defensive in your portfolio and asset allocation.
This is the main reason we spend a significant amount of time trying to understand your goals for your money – and the level of volatility you are willing to accept to pursue those goals. We talk with you regularly about the tradeoff between risk and reward in review meetings. We use Risk Tolerance Questionnaires to see what clues your answers provide about how volatility makes you feel.
Answers to questions about risk tolerance are much more telling in a downturn. Volatility is obviously a positive experience when markets are strong… but downturns are a good time to check how comfortable you are with your strategy. With the chaos happening in the world right now, this is a great time to revisit these questions.
Interest rates are still close to zero. To meet your long-term goals, you likely need at least some exposure to equity markets. The answer will almost always be to stay invested – but it must be in a portfolio that allows you to stay the course.
