We believe in an evidence-based, disciplined approach to investing. Once an investment plan is established and courses of action predetermined, market volatility like that which we’ve been experiencing lately won’t phase you at all. Right? Wrong. Having a plan in place doesn’t mean you feel any differently during market swings, but it just might stop you taking action based on those feelings – actions that might adversely impact your future investment experience.
If you’re easily spooked by market dips you might be feeling that it’s time to drop your stock holdings in favour of bonds or cash in case things get a lot worse. On the other hand, perhaps you’ve been predicting this precise timing for a market drop and the recent volatility has you feeling emboldened and tempted to double down on your bets. Maybe you just want to scream. While these feelings represent different ends of the emotional response spectrum, they are equally as dangerous to you as an investor. If these feelings are strong within you, you should use this opportunity as a dress rehearsal to test your gut in case things get really volatile.
Investment success means committing to the long term and sticking with an investment allocation that is suitable for your risk tolerance. Your risk tolerance is in turn driven by your need, ability and willingness to take risk. Your emotional response to the current volatility should be giving you some good signals as to your willingness to take risk. Treat this as a dress rehearsal before the real show gets underway – you want to be as prepared as possible so take the opportunity to test your risk tolerance and prepare yourself properly. If you want to achieve investment success you have to be willing to ride out all the periods of market volatility. While most investment plans consider average annual market returns, in fact volatile returns are a lot more normal than most people think.
In a Bloomberg article from April 2015, Barry Ritholtz examined data from Dimensional Fund Advisors and concluded that “Average, as it turns out, is surprisingly rare. Radical standard deviations year-to-year only even out over long periods of time. In any given year, markets are much more of a roller coaster than the averages might suggest.”
What we’ve experienced over the last couple of weeks isn’t even that volatile in the grand scheme of things – we sort of ended up where we started. It’s likely not even enough of a swing for most people with a disciplined approach to rebalance their portfolios. The financial media would have you believe the end of the world is nigh. Sure, it might get a lot worse. Or, it might get a lot better. You don’t know, I don’t know, and neither does anybody else. Use this opportunity as a dress rehearsal, deepen your understanding of your risk tolerance and prepare yourself as best you can by creating a plan that matches it.
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