Staying the Course in Volatile Markets: Why Doing Nothing Is Often the Best Strategy

Staying the Course in Volatile Markets: Why Doing Nothing Is Often the Best Strategy

In times of market volatility, it’s natural for investors to consider taking immediate action. Sharp declines in stock prices or unsettling economic headlines worldwide can prompt a rush towards selling assets and moving to safer ground. However, the best course of action during such times is often strategic inaction, or more simply, staying the course. Here’s why maintaining your investment strategy in turbulent markets is the smart move for long-term investors:

1. Market Timing is Nearly Impossible

One of the biggest reasons to avoid rash decisions during a volatile market is the difficulty of accurately timing the market. Predicting exactly when to sell before a downturn or when to buy back in before a rally is extremely challenging, even for professional investors. Historical data underscores this point as a few missed days in the market can significantly impact long-term returns. Historical data shows that markets tend to recover over time, and those who stay invested are more likely to capture those rebounds.

A study conducted in 2022 looked at the returns for the S&P500 between December 31 2006 and December 31, 2021 (15 years), and if you remained invested for all 15 years, through the 2008 global financial crisis, the European Debt Crisis, the Covid Crash, and many other crises that occurred, you would have averaged 10.66% per annum. However, by mixing the 10 best days in the market, your return would be cut by more than 50% down to 5.05%, and by missing the 20 best days, you are further cut down to an average return of 1.59% per annum. Making matters worse, if you missed the 30 best days, you would have had a negative return of -1.18% per annum. All this to say, market timing is near impossible and by simply missing the best days in the market, your returns can be seriously impacted.

Applying this to some recent examples, during 2020 during the pandemic-induced selloff, many investors panicked and sold at the bottom. Those who stayed invested saw the markets recover remarkably within months. Trying to time these ups and downs often leads to missing out on the most profitable days. Another recent example in summer 2024 was the panic that occurred over the collapsing of the US-Yen carry trade, but within a week the market was back to its prior levels and those who sold would have sold for no benefit, leaving them worse off than had they held steady.

2. Long-Term Gains Outweigh Short-Term Losses

Daily market fluctuations can be disconcerting, but they are often just short-term noise within the broader context of long-term growth as historically, markets have trended upwards over the long term. A diversified portfolio of quality stocks, bonds, and other assets is designed to grow over years, not days, and is designed to withstand dips in the market.

Historical performance of markets, such as the consistent long-term growth of the Canadian market despite economic downturns and financial crises, provides a compelling argument for maintaining a steady investment strategy guided by patience and a long-term mindset.

3. The Power of Compounding

One of the most powerful mechanisms in investing is the ability to compound returns. By staying invested, your assets generate returns not only on your initial investment but also on the gains those investments have already accrued. This effect is cumulative, meaning that the longer your assets are invested, the more significant the benefits of compounding. Interruptions in your investment strategy, such as selling off assets during a downturn, can significantly hinder the potential of compounding, reducing your long-term investment growth.

For example, if an investor sells in a panic during a downturn, they may miss out on the recovery that follows. By remaining invested, even in turbulent times, the gains from a market rebound will compound over time, leading to significantly larger returns down the road, and most often, the best days in the market follow the worst days.

4. Emotional Investing Leads to Poor Decisions

Investing is not just a financial challenge but a psychological one. Emotions can drive significant swings in investor behavior, leading to potentially poor investment decisions. When markets fall, fear can provoke selling during downturns, leading to decisions that are not based on rational analysis. Likewise, when markets rise, greed can lead to buying during unjustifiable highs.

Allowing emotions to dictate your investment decisions often results in buying high and selling low—precisely the opposite of a sound strategy. The inherent biases experienced by individuals who don’t have a framework in place and rely on emotions, are often led astray to their detriment, and often become disillusioned and frustrated, potentially leading to further ill-advised actions.

As such, by adopting a disciplined, long-term approach and resisting the urge to act on short-term market movements, investors can avoid the common traps of emotional investing.

5. Diversification Provides Protection

A well-diversified portfolio is designed to withstand market volatility. It spreads risk across various asset classes, sectors, and geographies, ensuring that a downturn in one area doesn’t disproportionately affect your overall portfolio. If your portfolio is already diversified, market volatility should have less of an impact, and there’s little reason to make sudden changes during temporary market swings.

Canadian investors, for example, often benefit from exposure to global markets, which provides an additional layer of protection, and also avoids one of the biases known as “home country bias”.

While the Canadian stock market may be volatile due to domestic issues, international investments can help balance out some of that risk and allow you to reach Canada’s market capitalization of 3%, accessing the remaining 97% of the globe.

Diversification also comes into effect with differing asset classes such as fixed income. By mixing fixed income alongside your equities, it can allow you to take advantage of market opportunities during a downturn. One way in which we do this is by using conservative fixed income to buy stocks that have declined in value, and upon recovery, use some of the gains to rebalance fixed income positions and prepare for future opportunities.

6. Strategic Rebalancing

Volatile markets may create opportunities for strategic rebalancing of your portfolio. This process involves realigning the weightings of a portfolio of assets to stay in line with your targeted asset allocation. It can mean buying more undervalued assets and selling off those that represent an oversized portion of your investments. Rebalancing can help you take advantage of lower prices and maintain your long-term investment strategy without veering off course.

Conclusion: Stay Focused on Your Long-Term Goals

While volatile markets can be unnerving, history shows that patient, long-term investors often achieve better outcomes. Reacting to short-term market movements can be detrimental to your investment health. Instead, adhering to a well-considered investment strategy and maintaining a diversified portfolio, adjusted periodically through strategic rebalancing, typically serves long-term financial goals best. Market dips may provide opportunities not just for buying quality assets at lower prices but also for making adjustments that can enhance future returns.

As your financial advisor, I am here to assist you through periods of uncertainty and ensure that your investment strategy remains suitable and aligned with your long-term objectives. Should you have any concerns about your investments or the market conditions, please do not hesitate to contact us.

Written by: Adam Prittie

Source: https://seekingalpha.com/article/4535147-time-in-the-market-beats-timing-the-market