"Volatility is a normal part of investing. We all know that markets go up and down - so we can be disappointed by downturns, but we shouldn’t be surprised by them."
- David Booth, Executive Chairman and Founder of Dimensional Fund Advisors
We can expect markets to fluctuate. But the financial media may amplify the perceived significance of an event and its expected impact on the financial markets. Investors should not let the crisis of the day, including what the world experienced during the COVID-19 pandemic, affect their long-term strategy and sentiment. Consider a few points that can help you keep the headlines in context.
The world has observed many previous crises, but capital markets have rewarded disciplined investors.
Major events around the world may have an influence on stock prices. But it is difficult to predict when these events will occur or how they will impact markets. What we observe from previous crises is that stock markets usually rebound.
You can never be sure how a single event will impact stock prices.
Many factors influence stock prices. Although major events and stock market movements may be related, it can be challenging to determine correlations. Also, after good or bad news, stock prices may not move in the direction that investors expect. It’s not enough to identify major events in advance, you also must accurately predict how markets will react.
Reacting to a crisis by leaving the market is just another form of market timing.
When investors move in or out of the market in response to an event, they are predicting when the market will have a positive or negative return. We believe markets incorporate all available information. Therefore, once information related to the event is known by investors, prices have already adjusted.
Additionally, if you flee the market after a major crisis, you must then decide if or when to return to the market. In many cases, the decision to reinvest comes after a rebound has begun, resulting in missed opportunity. Moving in and out of the market can also incur additional costs and have potential tax implications for investors.
Dealing with the uncertainty associated with major events is one reason why investors earn a return over time.
If there were no uncertainty regarding future events and the impact on stock prices, why would investors earn a return greater than the risk-free rate? While major events and their unknown impact on stock prices create uncertainty for investors, uncertainty is a major reason why investors earn a return.
Investors are better prepared to apply discipline during a crisis if they have realistic expectations, take a long-term view of markets and understand why some investments have higher expected returns.
Responding to the latest news and exiting the market may not alleviate anxiety.
Markets fluctuate daily in response to news and sometimes they experience significant declines. This can create anxiety for investors. However, exiting the market and then watching a subsequent rebound in stock prices can be just as unnerving. In this case, the stress of being in the market is replaced by the stress of being out of the market.
Also, the perceived significance of major events may not align with realized investment returns. Adjusting your portfolio frequently in response to negative news introduces stress in many ways, which can affect your overall investment experience.
Proper diversification, prudent investment management, and a goals-driven asset allocation can help investors endure a market downturn.
Stock prices fluctuate through time, and there will be periods when prices fall. However, a major event in one market may not affect stock prices in all markets - which is one reason to hold a globally diversified portfolio.
In addition, other asset classes, including fixed income, can help minimize the overall volatility and price impact on a total portfolio. Having an understandable strategy that accounts for market changes can help you look past daily news and focus on the long term.