Ryan Modesto, CFA, is CEO at 5i Research, a conflict-free investment research provider for retail investors offering research reports, model portfolios and investor Q&A, which is available to try for free. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation.
No one likes a market that declines.
It is more than money that is lost. It is hard work, lifestyles and an ability to support families and retirements.
We could try to calm an investor down by pointing out that this is a fairly normal market move and that investors might just be forgetting what volatility feels like.
In the last ten years, for example, there have only been three instances where the TSX saw a pullback of 10 per cent or more over a quarterly period, according to Refinitiv data. If we skip back to the period of 1998 to 2008, there were seven instances.
Market drawdowns happen and the world keeps turning and companies continue to sell widgets over the long-term. This does not make the short-term pain any easier though as we have outlined before, so having a game plan of what an investor should be doing in this type of market can be helpful.
Assess your risk tolerance – In a positive trending market, an investor thinks they can take on more volatility than in reality. It is easy to envision oneself hanging on in a 10-per-cent downturn when there have only largely been 10-per-cent upside moves in recent memory. Once the downturn starts to take hold and recent gains melt away, an investors true tolerance for risk can show. Don’t ignore this pain. Take note of it and ask yourself if you are holding the right mix of stocks, bonds and cash. No matter who you are, you will feel a downturn like this but if you are losing sleep at night or getting stomach aches or concerned about an ability to pay bills, this could be a good sign that the overall asset allocation needs to be adjusted.
Assess your timeframes – Times like this can be a good reminder that an investor needs to think long-term and be able to stay invested long-term. When markets go up year over year or at least stay relatively flat, it can be easy to forget this. Even if you are certain a market or investment is going to go up, that investment could stay down for say two years before it makes a profit in year three. If you need that money before year three, it does not matter how good an investment it was because the investor did not have enough time for things to work out. Make sure that you have an appropriate timeframe so you can wait out short-term downturns and let markets do what they do over the long-term (which is generate positive returns hopefully). Market participants often cite average market returns in the 5=7-per-cent range, but all of the volatility year to year in order to get to those averages is what gets missed. These averages are formed over decades not quarters.
Dust off your watchlist – It can be helpful as an investor to have a list of investments one would like to make when they have extra cash or when a good company shows a better opportunity. If you don’t have this list, now can be a good time to create one. Look at those investments you have wanted to make for a year now and still have great fundamentals and evaluate if it makes sense to put money to work at more attractive prices. This can keep an investor organized and focused when downturns happen. If you were someone who has avoided markets due to valuations, that primary issue has likely taken care of itself at this point. If you are still not satisfied, one might need to evaluate if those names should be on a watchlist at all.
Have or develop a process – If you already have the above three items under control, this is where having some sort of process can help. There is no silver bullet on how or when someone should deploy money but having something that keeps you honest and takes advantage of opportunities that arise can go a long way. The bad news here is that you are unlikely to time these things perfectly. Many will invest money ‘today’ to see markets drop tomorrow and some will wait until ‘tomorrow’ and watch markets go higher ‘today’. Understanding that you cannot predict these short-term moves and that this is a marathon and not a sprint is important. If an investor can handle this, then having some sort of process where a proportion of cash is put to work when markets drop by a certain percent or one rebalances a portfolio when markets move a certain amount can remove a lot of the guessing and fear that goes along with investing in a bad market.
A reader might notice that a lot of the points outlined above relate to doing nothing and taking this as an opportunity to evaluate your portfolio structure to ensure it is doing what it should be and that it is performing how you would expect in these types of environments. If everything checks out, it probably means not a whole lot needs to be done. Knee jerk reactions to short-term moves and turning a portfolio upside down is probably not the appropriate course of action. Once an investor has had time to catch their breath, it then makes sense to start thinking opportunistically and methodically to consider making investments they have held off on or have been waiting for a better opportunity to average into. Since there is a good Warren Buffett quote for almost any situation, we will leave you with this classic which speaks to market corrections and downturns: Be fearful when others are greedy and greedy only when others are fearful.