In financial markets, there is nothing more feared than a bear market, characterised by a more than 20 per cent drop in asset prices. After all, no one likes to see their investment going down in value.
Yet, investors suffered a vicious equity bear market last year.
To top it off, bonds also fell sharply, making it one of the worst years over a 150-year history. Not surprisingly, investors were cautious entering 2023, especially with the consensus expecting a recession this year. Bloomberg dubbed this as one of the most anticipated recessions of all time… As we fast forward to the present, the S&P500 volatility index (VIX), the equity market’s so-called fear indicator, has fallen close to its pre-pandemic lows. While this might suggest that investors are underestimating risks, thus raising the probability of a potential market pullback, it is crucial not to lose sight of the bigger picture: the importance of staying invested for the long-term.
Timing the markets is notoriously challenging, even for experienced professionals. As the equity rally continues to wrong-foot many investors, there are some valuable lessons to be learned.
Fixations
Don’t be overly fixated on predicting recessions or bear markets when making investment decisions.
The saying ‘Economists have predicted nine out of the last five recessions’ serves as a reminder of the pitfalls of such predictions. Often, the best days of returns in equity markets occur alongside the worst days of returns. Hence, missing just a few of the best-performing days, while trying to time recessions and recoveries, can have a substantial impact on overall portfolio returns in the long run.
My general philosophy is to buy stocks when they are down (during recessions). While this approach does not guarantee better outcomes, lower purchase prices generally lead to higher expected returns.
Focus on long-term returns
This is what truly matters for our investment portfolio. Yearly returns can fluctuate significantly from one year to the next, but the 20-to-30-year rolling returns tend to remain relatively stable. There will always be worries regardless of market conditions - whether it is concerns about further market declines or a pullback after a sharp ascent.
The key to success in investing lies in recognising that the long-term perspective is the most crucial time horizon to keep in mind.
Consider ‘dollar cost averaging’, instead of completely staying out of the market. This means, instead of trying to time the markets, consider the benefits of regularly investing a fixed amount at predetermined intervals, regardless of market conditions.
‘Dollar cost averaging’ allows you to buy more when prices are low and less when prices are high. Over time, this strategy can help smooth out the impact of market fluctuations. Importantly, it also instils a disciplined approach to investing, helping one to stay on course without succumbing to emotional reactions to short-term market movements.
By consistently contributing to your investments, you will be building a strong foundation for wealth accumulation and taking advantage of market opportunities along the way.
Stay diversified
Regularly review and rebalance your investment portfolio. Diversifying your investments across asset classes and regions is a time-tested way to maximise the chances of achieving your long-term return objective, while minimising your risks.
However, market movements can cause your diversified asset allocation to drift away from your intended risk profile. Hence, you need to periodically reassess your portfolio and rebalance it back to your target allocation.
Rebalancing, by definition, also leads an investor to buy assets which have gone down in prices and take some profits in assets which have gone up in value, regardless of your market views. In that sense, it is an implicit ‘buy low, sell high’ strategy.
We are all naturally risk averse. Economic and market uncertainty, following the once-in-a-generation events of the past few years, can exacerbate this innate risk aversion. However, by following the time-tested investment principles highlighted above, one can stay on track to achieve one’s long-term financial objectives, without taking on undue risks.
