Accompanying the entry of 2016 is the continuation of market volatility. With concerns about the Chinese economy and oil, we do not anticipate a slowdown in the negative news cycle. Sharp market movements to the downside, coupled with headline news, is a recipe for understandable anxiety for investors. Let us put the recent market volatility into perspective.
While past investment returns are not necessarily indicative of future results, the graph below illustrates intra-year S&P 500 declines and calendar year returns from 1980 to 2015. This allows us to put intra-year market losses into perspective. Despite average intra-year declines of 14.2 percent, annual returns were positive 27 of 35 years.
This illustration indicates a few things:
1. It is common for intra-year market declines to occur.
2. These intra-year declines can occur during calendar years in which the market realizes both positive and negative returns.
3. The market, when viewed through a short-term lens, remains unpredictable.
While we refrain from trying to predict what will occur in the markets over the next year (or three), we do want investors to understand market volatility is common and thus, negative intra-year declines are a poor predictor, which ought not lead one to abandon a financial plan or asset allocation.
Investing is difficult; that is a reality. We are all, as humans, predisposed to loss aversion and investors tend to strongly prefer to avoid losses to acquiring gains. Successful investing over the long-term, requires us to welcome short-term market losses in order to reap the rewards.
What can investors do to help during times of short-term market losses or volatility?
1. Have a plan in place and stick to it. We want a firm understanding of what you need or desire to achieve with your investments. Your capital should be deployed in a manner in which you are positioned to meet those goals without assuming more risk than you can tolerate or need.
2. Ensure you’re diversified in non-correlated assets. Do not take more risk than necessary. A diversified portfolio allocated amongst appropriate asset classes will provide greater risk management. Never forget the outsized majority of your returns are a product asset allocation and not company specific exposure.
3. Have an Investment Policy Statement (IPS) in place. An IPS is a roadmap summarizing your financial goals, current financial resources, risk tolerance and allocation of your investments to meet your goals. If you do not have an IPS, please request one from your advisor.
4. Ensure assets are allocated to accommodate your capacity and tolerance for risk. Nothing more than a market contraction will test your tolerance for short-term losses. There is a greater likelihood one abandons a plan by selling assets during a downturn if there is a mismatch between risk tolerance and investment allocation.
At MFG, we remain committed to fully and deeply understanding our clients’ financial goals, behavioral biases, risk tolerance and current and future financial resources. Allocating capital requires a great deal of discipline and we take great pride in providing a process and level of service that assists our clients.