Maintaining your composure

These are unsettling times. It is no surprise that the growing ramifications of the coronavirus pandemic have reverberated through financial markets.

Price action across all asset classes has become increasingly erratic. Some of the largest intraday swings on record in equity markets were seen in March, as the decade-long bull run crashed to an abrupt end.

Volatile markets are uncomfortable at the best of times. But they can feel even more so when their main driver is so obvious and experienced first-hand, and dominates hourly news flow.

Emotional call

Holding falling assets, combined with uncertainty over when the bottom will be reached, can take an emotional toll on investors. Staying invested, or even making new investments, as others run for cover requires considerable composure and discipline. It is when markets look most precarious that our behavioural proclivities can lead us astray.

To help investors, we examine some behavioural issues to consider during both present – and future – storms. While the coronavirus will eventually pass, it will not be the last event to cause extreme uncertainty in markets. Both Brexit trade talks and the US elections loom on the horizon as key events for 2020 outside of the virus.

The costs of action

People, as a general rule, don’t like uncertainty and it is natural to want to take actions that give us a sense of control. Recent panic buying in supermarkets is an obvious example of this. The prospect of significant financial losses is undoubtedly unnerving. Gaining a sense of control, by selling assets, may provide comfort at a time when we have lost control in many aspects of daily life.

While stepping out of the markets may help investors sleep better at night, selling will crystallise paper losses. And any short-term, emotional comfort can come at the expense of long-term gains critical to meeting long-term investment objectives. Many of the best days of market performance have followed the worst; and missing just a few of these “best” days will significantly impact cumulative long-term performance.

Time in the market is key

History shows us that “time in the market” is more important than “timing the market”. Once out of the market for emotional reasons, it can become more difficult for an investor to get back in. Emotionally-driven investors tend to wait until markets are rising enough to feel “safe”, which risks missing out on much of the recovery. This is the opposite of the maxim to “buy low, sell high”.

Studies into trading behaviour of individual investors have found a significant performance penalty of high portfolio turnover. As renowned US investor Benjamin Graham said, “The investor’s chief problem - and even his worst enemy - is likely to be himself.”

Focusing on the long term

Given the troubled market conditions, for investors wanting to take some action, one course of action may be to look longer term. This can include reviewing your overall investment objectives and financial situation, checking your portfolio is positioned to reach them over the long term and assessing whether there are new opportunities that can help achieve them. For investors looking to deploy more capital, averaging in over a long period of time remains the most appropriate strategy in the face of continued elevated volatility.

Reframing losses

Many of the actions taken in downturns are driven by the fear of losses. Losses have been shown to have twice as large an impact on us psychologically than equally-sized gains. This is why we do all we can to avoid them. Known as loss aversion, it can lead many investors in turbulent times to sell despite having sufficient liquidity to meet financial commitments.

Investors should remember that “losses” are just on paper. They aren’t realised unless an investment is sold. It is the future value of investments when they are sold, and not the present value, that is important. Short-term decreases in value are an inevitable feature of holding risky assets – the reason investors can earn a premium is due to the risk of potential losses. One way to look at large decreases is from the point of view of the potential for higher long-term expected returns.

Financial crisis flashbacks

The present environment may bring about memories of the great financial crisis in 2008, which took many years to recover from and may have left lasting emotional scars. The present downturn has been caused by the uncertainty of the impact of a global health crisis, not by imbalances in the financial system. While the effects continue to evolve, fundamentally it is an external shock that is transitory in nature. One that should have a different recovery profile.

While the financial crisis and the global response to it unfolded slowly, markets this time have fallen very quickly, matched by swift monetary and fiscal action. While historically, it’s taken an average of 143 days from entering a bear market to the low, this sell-off took markets into bear territory in just 16 trading sessions, as opposed to 136 on average in previous downturns. In this sense, we might expect, if the conditions are in place, an upturn to be quicker than in previous instances – which averaged 63 trading days to exit a bear market.

An unknowable future

While the future is unknown, it may appear even more so presently. This is understandably disconcerting to investors, so adherence to a robust investment process and a considered approach to assessing risks and opportunities is more important than ever.

Market cycles understandably trigger our emotional instincts to protect ourselves, but the best way to avoid impulsive urges that could ultimately prove costly, is to keep our heads and maintain a sense of perspective.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

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