Investors get easily caught up when markets rise or fall sharply. Afraid of losing money, they may decide unwisely to withdraw money and reinvest it when markets recover.
Yuvern Dokie, senior technical investment specialist at Alexander Forbes, says: “Our finances are personal and we might easily make a knee-jerk reaction if we feel like they are being threatened – which might harm us in the long term.”
“Our instinct to protect strengthens these tendencies. Making a quick decision that we feel will help protect our investments is the most natural reaction, but is it always the correct one?”
An investment journey consists of both smooth and bumpy periods. Sharp short-term rises and falls in the market during 2020 remind us of the importance of focusing on the bigger picture instead.
Dokie explains that the bigger picture is big for a reason. “It serves to remind us how easily we can make impulsive decisions when we are under pressure. In most cases, we would have been better off not being reactive and rather considering if our decision aligns with what we aim to achieve.”
According to Dokie, 2020 has proven all the rules of investing that we believe in:
Stay committed to long-term goals
The markets can be a scary place at times, but long-term investors shouldn’t panic.
It is nearly impossible to time the market
Changing an investment strategy designed with the long term in mind because of short-term ups and downs often ends in missed opportunities or even losses.
What goes down will go up
Past performance of investment returns reminds us that the gains experienced over many years outweigh the losses experienced in a few months.
Don’t put all your eggs in one basket – spread the risk
The right mix of defensive and growth investments can help protect your money during market shocks and grow it again when the market recovers.
Sometimes not acting is the best reaction
The graph below shows that defensive investments, such as cash, protect your money but are not ideal for growing it. For a short period from February to April 2020, exposure to cash would have protected your money, but would have lowered your long-term retirement outcomes over many years.
Stay invested and don’t try to time the market, especially in uncertain times
Say you withdrew from growth investments, such as shares, during the crash and couldn’t go back into the position you were previously invested in. Your money would have lost out on all the growth retrieved during this period. Trying to time the market is always a tricky exercise – time in the market is more important than timing the market.
Trying to time the market and reacting in fear will have different outcomes. An investor may have chosen to invest in 2020 in four different ways, each with different outcomes:
- Example 1: Invest in cash over the year
- Example 2: Invest in shares over the year
- Example 3: Invest in shares at the beginning of the year but switch to cash during the crisis (at the end of February 2020) and do not invest back into shares
- Example 4: Invest in shares at the start of the year, switching to cash during the crash (at the end of February 2020, then investing back into shares during the recovery (end of April 2020).
Example 4 above shows the investment outcome one would have achieved with perfect hindsight – a trait that most dream of having, but none possesses. This example is the ‘what if’ of investing and shows what the initial investment would have grown to if future events were known. Since we don’t know the future, staying invested as in Example 2 would have been a pleasing outcome.
These examples confirm tried-and-tested investment philosophies. Attempting to outsmart the market by determining when to switch between strategies ends in missed opportunities or even losses.
“Simply put, investors who sought safe havens in cash would have been worse off than those investors who remained invested in shares throughout 2020, even with the sharp market falls experienced earlier in that year.
“The times may have changed, but sound investment principles haven’t and still apply today. Investors who remain calm, stay invested and rededicate themselves to their long-term goals are better positioned to achieve future investment success.
“It is important that investors speak to their financial adviser before considering any changes to their current position. The right expertise, at the right time, will help highlight what goals are most important and ensure that any decisions taken are done so thoughtfully, in a way that’s right for their needs and investment period,” concludes Dokie.
PERSONAL FINANCE