Given recent market events, I am sure it wouldn’t have escaped your attention at the impact that this is having on world stock markets, as they adjust to the short-term economic implications (the outlook for earnings from companies) due to the Coronavirus outbreak.
In fact, the one thing I can guarantee is that you’re aware of ‘bad news’. It’s the media’s job to tell us ‘bad news’ and ‘bad news’ is what sells media. ‘Bad news’ is endless and seemingly perpetual as we now have the state of 24/7 ‘bad news’ that repeats and repeats, on and on. The only escape is to turn off the source of the media, because I can assure you that the media doesn’t have your financial planning best interests at heart.
Modern media moves from crisis to panic and back to crisis. We are never ‘crisis-less’. Don’t make investment decisions based on what you read or hear from a publication built for the sole purpose of grabbing your attention and selling advertising.
However, it is important to understand that market volatility, like we have experienced in recent days, is perfectly normal, however uneasy this may feel.
When the value of your investments is falling, it’s hard to imagine them ever bouncing back. We start to listen to our emotions. What were we listening to when markets were rising?
Understanding our Decision Making
Firstly, lets put this into some context. Investment markets rise for 75% of the time and they fall for 25% of the time. Yet, it’s the falls that people remember for longer. We call this loss aversion, and this is one example of Behavioural Finance in operation, which in this context can help us to understand how the mind can help or hinder investment success.
One should remember that this sudden change in direction from some financially illiterate investors is off the back of a 12-year bull market (a market in which share prices are rising) following the financial crisis of 2008/09.
Behavioural finance holds out the prospect of a better understanding of financial market behaviour and scope for investors to make better investment decisions based on an understanding of the potential pitfalls. It helps us to understand the psychology of financial decision-making.
Most people know that emotions affect investment decisions. Behavioural finance helps us to understand the role of our biases in decision making, even if we are not aware of them!
These biases can affect all types of decision making, but they have implications in relation to money and investing and tend to sit deeply within our psyche. They could serve us well in certain circumstances but in investment they may lead us to unhelpful or even hurtful decisions. An analysis of these biases is beyond the scope of this article, but it is important to know that they exist whether we are aware of them or not.
Working with a financial planning firm can help us to become aware of them and how they may be causing us to react in a certain way, sometimes to our detriment. With help from an adviser, we can begin to loosen their grip and make decisions that work in our long-term best interests.
If you cannot control your emotions, you cannot control your money.
Key Facts about Stock Markets
- Market Corrections are normal
The long-term trend of markets is upwards but is interrupted by market corrections. This is perfectly normal but cannot be predicted. Everyone remembers the financial crisis of 2008, but what followed was the longest bull market in recent history.
Just like the pattern of the seasons, there are clear patterns in financial markets that are evident through many decades of data.
Since 1900, market corrections occur on average once per year. In other words, corrections are a regular part of financial seasons – and you can expect to see as many corrections as birthdays throughout your life.
The average correction is 54 days long, occurs once a year and the market declines on average 13.5%.
The uncertainty of a correction can prompt people to make big mistakes – but in reality, most corrections are over before you know it. If you do nothing, it’s likely the storm will pass.
Morningstar see volatility as an investment opportunity – see their short video here.
Instead of living in fear of corrections, you and I have to accept them as regular occurrences — like spring, summer, fall, and winter.
- Fewer Than 20% Of all Corrections turn into a Bear Market
When the stock market starts falling it can be tempting to abandon ship by selling assets and moving into cash. However, to do so could be a big mistake. You would likely be selling all of your assets at a low, right before the market rebounds!
Put another way, 80% of corrections are just short breaks in otherwise intact bull markets – meaning that selling early would make you miss the rest of the upwards trend.
- Nobody can predict consistently whether the market will rise or fall
The media perpetuates a myth that, if you’re smart enough, you can predict the market’s moves and avoid the falls.
I’ve never met or heard of anyone that can successfully predict markets, but many try. To me that is folly. We have to learn to align our financial planning in harmony with markets.
There have been many predictions over the years from some very famous financial commentators, which have been completely wrong.
The only value of stock forecasters is to make fortune-tellers look good.
- The market has always risen, despite short-term setbacks
Market drops are a very regular occurrence. For example, the S&P 500 – the main index that tracks the U.S stock market – has fallen on average 14.2% at least one point each year between 1980-2015. Like winter, these drops are a part of the market’s seasons.
Over this period of time, despite these temporary drops, the market ended up achieving a positive return 27 of 36 years. That’s 75% of the time!
The market generally rises over the long run — even though we hit a huge number of potholes along the way. Over this period of time, there have been multiple wars, the worst financial crisis since the Great Depression, and many other roadblocks – despite this, the market is still up!
The biggest danger isn’t a correction or a bear market, it’s being out of the market.
- Historically, bear markets have occurred every three to five years
In the 115-year span between 1900-2015, there have been 34 bear markets. In those situations, stocks dropped 20% or more.
- Bear markets become Bull Markets
Do you remember how fragile the world seemed in 2008 when banks were collapsing, and the stock market was in free fall? When you pictured the future, what did it look like? How do you picture the future today?
The fact is, once a bear market ends, the following 12 months can see crucial market gains.
The stock market is a device for transferring money from the impatient to the patient.
- The greatest danger is being out of the market
From 1996 through 2015, the S&P 500 returned an average of 8.2% a year. But if you missed out on the top 10 trading days during those 20 years, your returns dwindled to just 4.5% a year.
If you missed out on the top 20 trading days, your returns were just 2.1%.
And if you missed out on the top 30 trading days? Your returns vanished into thin air, falling all the way to nil!
You can’t win by sitting on the bench. You have to be in the game.
To put it another way, fear isn’t rewarded. Courage is.
From these interesting facts we can develop a set of principles and constants for addressing uncertainty. Here are a selection that I hope are helpful.
- The stock market rewards the patient and punishes the rest.
- The risk in the stock market is not being in it. Don’t react and sell at the bottom. Take a long-term approach and possibly consider adding more to investments during market falls (subject to advice).
- When you invest in the stock market (the great companies of the world) you’re investing in real companies, who sell real things to real people.
- Consider drawing income / regular withdrawals from cash reserves rather than your portfolio during market falls. That’s why you kept an emergency fund.
- Stock market volatility is always temporary, always expected and always feared by those who don’t understand it. When the markets are down, we refer to this as a ‘big sale’. The advance is permanent, the declines are temporary.
- No one can time the markets, identify in advance a winning sector, winning fund manager or winning country. Therefore, we don’t try to do this or claim to know how to do it. We operate from a position of diversification, ensuring you don’t hold all of your eggs in one basket.
- Lifetime investing success has very little to do with investment returns, but a lot to do with investor behaviour. Investing is more emotional than intellectual.
- Successful investing is about ‘time in’ the markets and certainly not about ‘timing’ the markets.
- Every successful investor continuously works on their financial plan, every failed investor continuously reacts to the market and current events.
Implications for Investors?
Markets will remain volatile and investors should ensure that their investments remain suitable for their circumstances and hold enough cash for any rainy-day needs. Those who are accumulating money could consider adding to portfolios when markets are lower. Those decumulating from their capital, for example when drawing an income, need to look carefully to guard against drawing down too much of their capital and eroding the underlying capital base. It is also essential to make use of tax allowances especially as these are constantly under review by the government. Experience tells us that our own human emotion is the biggest threat to our own portfolio. Investment decisions based upon emotion are nearly always wrong!
For clarification of any points discussed above and any future independent advice regarding your own financial planning, please do contact us on 01626 833225 or email [email protected]
The views and opinions contained herein are those of Loughtons Independent Financial Advisers and may not necessarily represent views expressed or reflected in other economic communications, strategies or funds.
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