During these good times should you be preparing for the upcoming bad times?
It is now almost 18 months since global financial markets crashed at the outset of the Covid 19 Crisis. During March 2020 many of the well-established Equity Indices across the world fell by 30%-35% in a matter of days.
The magnitude and speed of the collapse was unlike anything previously experienced in financial market. What has happened in the year and a half since then is an equally impressive recovery.
All benchmark equity Indices across the world are up significantly year to date and many have surpassed their All-time Highs. The major US Indices such as S&P 500, Dow Jones & the Nasdaq have all set new all-time highs, The European Stoxx 600 index also hit its highest ever level during Aug 2021.
Markets are going up on a daily basis and for anyone who watches the performance of their investments or Pension regularly (I recommended you do not do this) they will also have seen the value increase.
Due to a cognitive phenomenon known as Recency bias, it may seem like Investing is easy at the moment, it’s a sure thing and you cannot lose. Recency bias is a psychological phenomenon where we give too much importance to recent events compared to what happens over the longer term.
Financial markets are cyclical, therefore it inevitable that this trend will end, markets will have a “correction” and you will experience dramatic reporting on TV and in print media. What should you do to avoid the impact of this when it eventually happens? During these good times should you be preparing for the upcoming bad times?
Here are some tips for you when that inevitable day comes and your stock market investment drops.
Don’t Panic Sell
Switching to a lower risk strategy or even cash to get out of a down market could have long-term implications and often cause you to miss out on some big gains when the market corrects. When your portfolio drops in value you must remember that this is only a temporary devaluation, markets will recover in due course (Take 2020 as an example).
If you move to cash or sell your assets then you are making this temporary situation into a permanent one and crystalising the loss. Try to remove the emotion from your investment decisions, if you are a long-term investor, your circumstances haven’t changed then there is no need for you to do anything.
Maintaining a diversified portfolio is one of the cornerstones of successful long-term investing. When equity markets are volatile the other assets in your portfolio should increase in value and provide you with the returns commensurate with your chosen risk portfolio over the long term. Many asset classes are inversely correlated meaning they will automatically ‘hedge’ your risk. If one asset is performing poorly, the hope is that you can offset these losses with better investment returns in another asset category.
Take advantage of Euro cost averaging
Some Investors with a higher appetite for risk often see a period of correction as a buying opportunity and try to make the volatility work in their favour. Rather than thinking of it as a 20% fall, think of it as a 20% reduction in the price of stocks so you can buy more. During periods of uncertainty and market volatility many investors are inclined to wait until things ‘settle down’ before committing.
Some investors try to predict the bottom of the market and try to ’buy in’ at exactly the right time. You can never fully eliminate this risk but you can certainly reduce the risk of buying at the wrong time by adopting an approach such as Euro cost averaging.
Quite simply, this is a strategy which involves contributing regularly into a particular investment at regular intervals over a period of time, more shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out.
Stick to the long-term plan
Its always a good idea to remind yourself of your long-term plan, keep your long-term goals in mind. When you began your investment, you may have had a 10-year goal such as College education or purchasing a holiday home, you still need to achieve these goals and ‘staying the course’ through volatile periods will make you more likely to do so.
No one likes to check their investments and see that the value has fallen, but we can train ourselves not to panic. Regular downturns in the stock market should not be feared, in fact they should be expected as part of the investment experience.
How you react to them is the key, one of the main reasons why many Investors are rewarded over the longer term is that they tolerate this type of volatility and remain invested. Warren Buffet summed it up best with his quote “The stock market is a device for transferring money from the impatient to the patient.”
Barry Kerr CFP® is Founder & Managing Director of Wealthwise Financial Planning who are based in Carrick on Shannon and Galway. All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland #CI6614
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