Investing in troubled markets: 7 principles that guide investors

Even in the face of devastating global events and extreme market movements, it is important to think long-term. Otherwise you should be afraid of losses.

Right now, our clients are asking us if they should start changing the positioning of their portfolios, change the distribution of assets or even set minimum prices. Our advice, as always, is to invest wisely, that is, maintaining a long-term vision and preferring relevant basic research, reliable data and proven strategies. Impulse investing can be dangerous.

1. Adjustment of the stock market – a natural phenomenon

Despite the trend of steady stock growth over a long period of time, history has shown that stock market adjustments are a natural phenomenon. However, there is good news: no correction (a drop of 10% or more), no bear market (with a time reduction of 20% or more) or any other bad period lasted indefinitely.

Market downturns occur frequently, but they do not continue

When markets falter, some may seek to reduce their influence on stocks. However, history shows that periods of market turmoil and sharp contractions later proved to be the best times to invest.

2. The duration of the investment is important, not when you invest

No one is able to accurately predict short-term market movements, and investors sitting on the sidelines risk missing periods of significant price increases following market contractions.

Each correction of 15% or more in the S&P 500 between 1929 and 2020 was accompanied by a recovery. The average growth during the year after these failures was 55%. Skipping just a few sessions can be expensive.

3. Impulse investing can be dangerous

It is perfectly legal to be moved by market events. However, while worrying when markets are falling is normal, it is the decisions made during these periods that can change success and failure.

One way to support sound investment decisions is to understand the basics of behavioral economics. By recognizing behaviors such as binding, confirmation bias, and availability bias, investors can identify potential mistakes before they make them.

4. Make a plan and stick to it

Carefully developing and adhering to an investment plan is another way to avoid short-term decisions, especially when markets are falling. The plan must take into account many factors, such as risk tolerance and short-term and long-term goals.

When we experience such episodes of instability, it is easy to respond by focusing on the short term. But in such an environment, the right decision is to adapt your investment horizon and see the long term.

5. The issue of diversification

A diversified portfolio does not guarantee a return or a guarantee that the value of the investment will not decrease. On the other hand, it reduces the risk. By dividing their investments into different asset classes, investors can limit the impact of volatility in their portfolios. In general, the results will not reach the individual highs of each investment, but they will also not fall as much as their lows.

For investors who want to avoid some stress during recessions, diversification can help reduce volatility.

6. Bonds can provide a certain balance

Although stocks are important components of a diversified portfolio, bonds can be an important counterweight. Because they are rather weakly correlated with the stock market, they tend to move in the opposite direction to the latter.

Qualitative stocks have shown their resilience, despite the difficult context

Moreover, low-correlated equity bonds can mitigate equity losses in the overall portfolio. Funds that offer such diversification can help create long-term portfolios, and well-chosen bond funds that have demonstrated their ability to generate positive results in a variety of market conditions.

Although bonds may not meet the growth potential of stocks, they have often shown resilience during previous stock market adjustments. For example, US underlying bonds have risen by at least 12% in four of the last five adjustments.

7. The market seeks to reward long-term investors

Is it reasonable to expect results of 30% per year? Of course not. Similarly, the decline in stock prices in recent weeks should not be seen as the beginning of a long-term trend. According to behavioral finance, recent events disproportionately affect our perceptions and our decisions.

It is always important to maintain a long-term perspective, especially when markets are falling. Although stocks rise and fall in the short term, they tend to reward investors for longer periods of time. Thus, during all 10-year periods from 1937 to 2021, the S&P 500 index generated an average annual return of 10.57% (including bearish phases).

During periods of market instability, it is natural to increase emotions. However, investors who manage to keep a cool head, ignore the news and stay abreast of the long term are better prepared to develop a smart investment strategy.