Investors tend to look at the positive long-term performance numbers of a selected portfolio believing its short-term performance will mirror the outcome.
Investors make an unrealistic assumption if they think that the investments they hold will continuously appreciate in value. A wise investor understands that having negative returns at some point in their investment cycle is probable. It is important that the investors risk tolerance is determined and understood.
Reality is that the investment world is full of uncertainties. At any point in time, market events could make a rational investment approach seem irrational.
There are two pathways an investor can take; short-term and long-term. The rational approach to investing is to be patient and take the long-term investment approach rather than the patience-deprived short-term pathway.
History tells us that the short-term investor reacts to the flow of short-term news. Conversely, the long-term investor will hold their course and make rational investment decisions based upon long-term business fundamentals as negative volatility may narrow over time. Long-term investors stand a better chance of stable returns on their investments.
There will always be worries associated with financial markets such as credit crunch, change in income trust legislation, technology appreciation, political unrest, civil insurrection or terrorist attacks. These situations may cause short-term investors to panic, leading them to make rash investment decisions. A long-term investor may be able to discover opportunities in turbulent times and add to their portfolios by choosing investments that have temporarily declined in value.
Historically, market volatility is constant. Prices rise and fall and, at times, the fall is hard. Keep in mind that short-term pain is the price an investor must pay for potential long-term gain that the stock market can eventually deliver.
Portfolio Diversification is Crucial
A good portfolio is one that takes risk tolerance into account. A poor portfolio is one that favours an ad-hoc process of investing in “what’s hot” at the moment. Research by Dalbar Inc. has shown that the average institutional investor who has a diversified portfolio outperforms the average retail investor who invests on an ad-hoc, emotional basis.
As a long-term investor you should not be emotionally affected by the market’s troubles of the day. You know that various sectors within the economy can and will be impacted at different times and degrees. To benefit from the market and maximize returns you must ensure that your portfolio is well diversified in areas such as asset class, geography, and investment style. If one component of your portfolio is negatively affected by volatility you can take comfort in the fact that the resulting loss may be mitigated by positive returns of another component.
Asset class diversification does not guarantee protection from negative returns but it may offer a cushion against major negative returns in volatile markets.
Focus on Long-term Objectives
Market volatility should be inconsequential to the long-term investor. Instead of focusing on the current investment value, focus on the future value of your portfolio when you will need your assets for a down payment on a home, college tuition or for retirement. If you must, or know you will, use your savings in the near-term, invest in cash or cash equivalents as this will eliminate dealing with market volatility.
Stay positive during periods of negative market volatility. Remember that during the 1987 stock market crash the Dow Jones Industrial Average fell 22% in one day. Less than two years later it had recouped all losses. After five years the Dow was up 41% from its pre-crash level and 10 years later it was up 253%.
Resist the urge to check prices every day. Opportunities to take advantage of price volatility will be constant. Sound, diversified investments managed by knowledgeable and experienced investment specialists will help you reach your investment and financial goals.
Discuss your investment strategy with an IPC Advisor today.