What to do when markets are turbulent

07/04/2022

In moments of market turbulence like the one we have been facing in the last few months, investors might experience panic, anxiety and/or fear, which could lead them to make impulsive investment decisions.

Recovering from downturns

In situations like this, it is important to remember that the stock market has experienced similar situations in the past and it has a long history of successfully recovering from hits like the one it's experiencing today.

Investors who sell out in bear markets instead of preserving their money end up making their losses a permanent situation. So, if possible, try to maintain your investments and wait for the market to recover.

Stock market fluctuations are outside the control of any single investor. So, only look at what you can control and avoid making abrupt decisions when economic conditions change and markets become volatile. Try to focus on key investing concepts such as being well diversified and rebalancing your portfolio to stay aligned with your investment goals.

A dollar-cost averaging strategy can also help you stay focused on your future and reduce or remove emotions from decision-making while continuing to invest, even in times of market turbulence and/or rising inflation.

Market timing

Some investors decide to sell their assets and try to buy them back at a cheaper price. It is extremely difficult to time the market successfully compared to staying fully invested over the same period of time.

Several studies show that the cost of waiting for the perfect moment to invest typically exceeds the benefit of the correct timing. And, because perfectly timing the market is nearly impossible, the best strategy for most people is not to try to market-time at all.

Also, investors may pay a high price for being uninvested. Missing the best days of the market will strongly impact the total return of your investments in the long run.

The following chart shows the annualised total returns of the S&P500 Index, in different scenarios:

Another study shows that over the last 20 years, the annualised return for the S&P 500 was 8.8%. If you remove the best 10 days of the market from the calculation, then the annual return of the S&P 500 drops to 4.6%. That is a reduction of 48% for not being invested in the best 10 days over a period of 20 years. Furthermore, if you do not consider the best 30 days, then the annualised return for the S&P 500 would be -0.2%.

Focus on the long term

Warren Buffet once said that uncertainty is the friend of the buyer of long-term values.

A long-term investor should not be too worried about the current environment; to the contrary, he should consider it an opportunity to buy cheap assets. Buying in a bear market tends to reduce the average cost or entry price of an investment in the processof dollar-cost averaging.

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