But it’s a marathon, not a sprint
Well, here is quite an admission: Underneath it all, money is emotional. We rarely talk about money like it is. It’s so easy to be unemotional and academic about it when things are going well and markets are up and we are making plans.
But those academic lessons of rigor with respect to investing are really tested by the emotional side when markets are volatile and go down. Because money represents dreams and goals and plans and ideas. And it is precisely at these times where commitment to your well-diversified investment approach will best serve you, but it may be a difficult commitment to keep.
The temptation to trade
This past quarter has been quite a test between investors’ emotional self and rational self and therefore their commitment to their portfolio strategy. And it is precisely these volatile markets that raise the most challenging questions to their resolve.
As was stated in The Investment Answer, “There are many behavioral inclinations that work to our detriment as long-term investors.”1 Unfortunately, these are the type of markets that trigger such inclinations and test commitment to long-term plans.
One of the greatest temptations of an investor is the urge to make trades to take advantage of what they assume the market volatility will produce in a return pattern. This inclination is pounded into us by much of the financial media these days, so if you are watching financial television, you are likely being influenced to break your commitment to your portfolio ideals and seek the bright, shiny object. In this case, that object is a perfect trade. The message from most of financial television does not actually support your best long-term approach. It turns out that such trading, more likely than not, will hurt long-term performance.
The futility of market timing
Unfortunately, it’s extremely difficult to time the market well enough to produce a set of perfect trades. And, make no mistake, it is a set of trades. If you wish to make a timing trade in the market, you not only have to plan for a trade to sell but also a trade to buy those securities back. Making a critical mistake on either trade nullifies the gains you sought. And this factor of needing to execute two trades really well means that the vast majority of attempts will fail.
The lack of timing skill can be seen even at the professional level. If you look at the performance of active funds versus index/passive funds, you will find that over a 15-year period (from July 1, 2004 through June 30, 2019), across all domestic funds, 87.76% of equity funds underperformed their benchmark.2
The proven path to good long-term performance
The good news is that investors don’t need to be able to time the market to have good long-term investment performance. Again and again, the data shows us that the approach most likely to yield the best long-term results is to buy a globally diversified portfolio.
This part is the marathon. It’s not easy to outperform this approach and very difficult to imagine that you are suddenly in that rare group that might outperform when over 87% of professionals are not able to do so. But you have an approach that typically dominates, and that is to stay the course to adhere to your long-term plans and goals.
There is some further good news in that markets tend to rise over time. They have setbacks — and big ones — at times, but over the long-term, markets rise as economies grow and develop. Overall, markets trend upwards over almost any long-term measure.
In the chart below, you can see some of the most challenging negative markets for the S&P 500 and note that the subsequent performance is positive. We don’t know the future and the exact timing, but historically the market continues to perform well. And those that stay the course usually participate.
A history of market ups and downs
S&P 500 Index total returns in USD, January 1926–December 20193
Using a 20% threshold for downturns
What’s your short-term financial plan?
If you have concerns, one consideration is to review your shorter-term cash flow needs. It could be that your concern over the market has to do with plans you had for later this year. Were you hoping to buy a second home? Or go on a dream vacation? Or needing to pay for college? Had you set aside money for these goals?
This is the time to review your financial plan and to see how to support your short-term financial goals, while keeping your eye on your long-term needs. Reviewing these plans and seeing how they fit in the current picture can provide you the support you need to continue with your long-term investing approach.
It’s typically easier to show commitment in good markets with positive returns. In volatile and negative markets, that commitment is tested, and the emotional side of investing rises, tempting you into an investment approach that is sub-optimal. However, if you consider the data, it shows that again and again, those who are able to stay the course are more likely to come out with favorable portfolio returns.
This is a great time to seek assistance from a financial advisor to review your situation. If you have any questions about the data we covered above or how to meet your short- or long-term goals, reach out to one of our advisors.