Without a doubt, the last 12 months have been challenging for everyone. The financial markets have been no exception, with unprecedented levels of volatility across many asset classes and a long list of financial market records broken, including the fastest ever bear market but also one of the fastest recoveries.
But, despite all the disruption, global equity markets finished 2020 higher than they had started as you can see from the chart below.
Source: Nutmeg, MSCI, MacroBond, 22/01/21
One of the key tenets to investing is patience and discipline: if you have the nerve to stay in the market through the bad times, then, as the evidence from last year shows above: you can be rewarded.
What other key lessons can investors draw from their experience through such a tricky time? Did the long-term rules of investing hold when it came to market behaviour? Faced with market volatility in the future, how can investors change their behaviour? What behaviours were rewarded and how could investors have best benefitted from the market volatility? Let’s have a look.
Patience and discipline pay
Investing is a long-term activity that rewards patience and discipline and where short-term volatility is par for the course. Learning to live with that volatility is one of the keys to investing success. Ignore the headlines and don’t let your decisions become emotional – this is especially true if you’re investing for a life goal such as retirement, which may be many years away. Research suggests that those looking to ‘time the market’ by exiting when it is higher and buying back in when it is lower, typically fare poorly compared to those that stay invested throughout. Those who panic and sell when markets are going down, only to try and buy back in when they go up again, could fare worst of all. Likewise, unless your goals, timeframe or capacity for potential losses have changed, there is no need to adjust your risk level.
It’s crucial to remember that a loss only becomes real when crystallised – which will happen if you withdraw your money from being invested. If the market drops and you are still invested then you still own the asset, that has not changed, just its current market valuation. If you still own it, you are in the best position to benefit from a market recovery that could raise its valuation. The evidence tells us that the longer you invest, the more likely it is you’ll see a positive return, and that timing markets is incredibly difficult and not advisable.
Volatility works both ways
Back in March we talked about the potential for downside AND upside volatility. Essentially, when markets are volatile, that means sharper moves up and down. The biggest up and down days in markets tend to have a level of coincidence: a big move in one direction may be followed by a big move in the opposite direction. In 2020 markets reacted strongly as the pandemic spread, they then corrected and recovered significantly – as shown by the graph above.
In March 2020 global equities experienced their largest ever daily loss – 9.9% on the 12 March – but following this we also saw three daily returns that qualify in the top 10 daily returns since records began in 1970 – 24 March: 8.8%, 13 March: 5.9%, 6 April: 5.9% (Source: Bloomberg, MSCI World Net Total Return in USD).
Staying invested is one way to navigate volatile market conditions. Had you left following the initial market dip on 12 March you would only have made losses and missed out on the recovery.
‘Carry on contributing’ was the right strategy
In the same way that some investors exit the market when it takes a downturn, others might look to stop their regular contributions when markets become volatile. But contributing through volatile periods is good investment discipline and can allow you to benefit when markets recover, and from pound cost averaging. When the markets recover, investors who continued to contribute through the market volatility have benefitted from the lower asset prices and the compounding of their returns.
Conversely, those that paused contributions due to volatility missed out on outsized returns and could heed this lesson for the next time around.
The long-term rules of investment held when it came to risk levels
The general rule for investors is that more risk can lead to higher returns but also higher potential losses. In 2020, on a broad basis, investment assets performed as they would have been expected to: the highest risk assets witnessed the largest losses in the first three months of the year but then had the strongest returns for the final nine months as certain indexes reached all-time highs. The lesson here is to make sure you’re comfortable with the level of risk you are taking and that it is appropriate to your investment goal. Taking on more risk may often mean you see higher losses as well as higher gains. In 2020, those accepting losses at the start of the year, saw higher gains at the end.
So, although 2020 was a tumultuous year, those staying invested in Nutmeg accounts would have been rewarded despite the record volatility. Even though there were clearly difficult moments, the data from 2020 suggests that staying invested, seeing through a downturn and continuing to contribute can help ride the wave of market volatility and realise potentially higher returns upon market recovery.
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.