Investing seems simple on the surface. Use your wealth to invest and over time the value of your investment should increase, hopefully commensurate with the risk you have taken. This high-level objective forgets that investment values gyrate, they are volatile - some assets are more volatile than others. Market volatility can be stressful for investors; the key is to take the appropriate amount of risk so you remain invested and have a chance of achieving your financial goals.
Financial planning requires time
Investing requires that you stay invested for a defined period of time, or at least with a minimum threshold. Over the course of this time frame, markets will inevitably deliver good years and weak years of performance. The risk taken is not one sided; investments don’t keep going up in perpetuity. Investors will suffer weak years.
Since the global financial crisis, the economy and markets have enjoyed central bank support, with low interest rates and frequent quantitative easing, which has resulted in unusually depressed levels of price swings in financial markets. For investors, the last 14 years have been rewarding: relatively low levels of price fluctuation with good returns.
Markets have started to change and we could see a move back to pre-financial crisis investment conditions. Rising interest rates and elevated geopolitical risk means investors should expect more volatility.
Investing is emotional
After working hard and saving, it's natural for investors to have a strong connection with their wealth. Investing involves an element of emotion and as time passes - depending on an individual's life, events, the economy and markets - sentiments change and people can feel differently about their investments.
Loss aversion is naturally wired into us; most people would prefer to avoid losing compared to gaining an equivalent value. So, when investors see the value of their portfolio drop they may feel the need to prevent further potential or expected losses; but this can work against them.
Emotions are in our nature, but how can we manage them in an effective manner, that ultimately results in a positive outcome to the financial plan?
The short answer is: perspective.
Perspective can provide comfort
When creating their portfolio, most investors put money into a mix of investments, normally bonds and equities. If we consider the riskier of the two, equities, we know that there has historically been a lot more volatility in equity prices. As a result, those with a higher exposure to equities have tended to see larger falls in value, but due to their volatile nature, those investors have also tended to see larger gains.
Markets go through strong and weak periods and falls in value are quite frequent. Throughout the years we will see falls and these can add up over time. However, we have tended to see more positive years than negative ones and, over time, they add up to offset the weak periods of performance.
Even with this knowledge, investors have looked for many different strategies to offset the risk associated with these periods of falling markets, but all approaches come with their own set of risks.
Timing the market is difficult
Investors have often tried to “time” the market – essentially selling to avoid falls in investment prices and investing to capture the upside. Selling assets crystallises your investment position. Losses or gains may have been made, but de-risking or moving to cash eliminates the prospects for future investment returns. Market volatility can result in drops in value, but it can also see similar movements in the opposite direction over time. Usually, periods of sharp falls and sharp rises, the best and worst days in markets, occur in close proximity.
Between 2001 and 2020, seven of the 10 best days of the S&P 500 index occurred within two weeks of the 10 worst days, and 6 of the 7 best days occurred the day after the worst of that year. The second worst day of 2020 - 12th March – was immediately followed by the 2nd best day of the year.
These data tell a story: remaining invested avoids decision making errors in the short term that can critically undermine the most robust of financial plans.
Sometimes taking no action, is the action.
How can FE Investments help?
FE Investments provides investment management expertise so that advisers can spend more time with their clients to help them achieve better outcomes. This means that we aim to manage risk in our portfolios and aim for a stable level of performance over the long term, looking to offset risk of volatile markets.
Our portfolios cover a wide spectrum of outcomes to ensure clients have enough choice of the types of investments they’d like to make. Our Hybrid, Income and Mosaic portfolios emphasise risk management, where ESG factors are part of the process but the objective is not such a high priority. In contrast, the Responsibly Managed portfolios combine sustainable and impact funds together, and delivers a more progressive outcome to do more good. By doing so, we can target a broad client base and help advisers advise their clients effectively.