When we see markets moving up and down rapidly due to volatility it’s only natural to check the state of our investments. And as investors see some of their hard-earned gains disappearing, they may well be tempted to pull funds out of the market and seek temporary safe harbour in cash. In this blog we examine the wisdom of this strategy (in truth better described as a reaction than a strategy per se).
When leaving the market is tIming the market
Unless you have decided to hang up your investing boots permanently (and we really hope you haven’t!) then by temporarily exiting the market before a later re-entry, you are effectively trying to ‘time the market’. By this we mean you are trying to guess the best exit and entry points against the movement of the market, and this is extremely difficult to get right. To illustrate how this can turn out we previously invented two investors who followed different hypothetical paths during past volatility; and right now may be a good time to remind yourself how things turned out for Alan and Megan.
Essentially, if you leave the market and then wait until you’re confident the market has bottomed out, you are likely to have already missed some of the recovery. And with that sort of timing, you might be surprised just how important a day either way could be for your portfolio. Between January 2000 and December 2019, if you missed the S&P’s best 10 days, your average annualised return would be 2.44% compared to 6.06% if you had stayed invested. In fact, the majority of these ‘best days’ in the past have tended to occur during times of significant market downturns, just when concerned investors might be sitting out.
Remember your portfolio is designed to endure volatility
Although the timing of volatility can be unforeseen, in general it is never unexpected. All Nutmeg portfolios are diversified to manage the risk of volatility [LINK TO BLOG 2], so whilst volatility might have an impact on a portfolio’s short-term value, they are designed with long-term performance in mind. This means they have a carefully managed risk exposure which prevents them from being overweight in a sector where our investment team deem they could be exposed to unacceptable risk. They also avoid spaces which we consider to be uninvestable, such as cryptocurrency. In the construction of our portfolios, we take into account observed relationships between asset classes – such as bonds vs equities – and provide you with our risk classifications based on this assessment. A higher-risk portfolio may see more volatility than a lower-risk portfolio, but each one is diversified within its allocation to help mitigate potential losses over the longer term.
Remember your goals and widen your perspective
At Nutmeg our clients have many different investment goals, and thus a wide variety of timeframes to reach those goals. In fact, the average investment timeframe for a Nutmeg client is just over 12 years. With that in mind during these periods of volatility, like the advice given to those feeling sick on rough seas, keep your eyes fixed on that horizon.
Let’s see a quick, and recent, example of a short-term v. longer-term view, even when the timeframe is shorter than those 12 years mentioned above. Below is a partial snapshot from 2020 (we’ll show all the data labels in the fuller view further down), but the graph shows March 2020 performance of Nasdaq (blue), S&P 500 (orange) and Dow Jones (light blue) indices.
It looks terrifying right? Run for the (cash) hills time perhaps? Now look back towards the horizon a little, and bring the same view up to date in the full graph below. The lines show the performance of the three indices since January 2020 (indexed to closing prices on March 23, 2021). So, an extreme example of volatility, the ‘covid crash’, was followed by 12 months of positive market growth.
But this is nonetheless quite a short-term perspective. If we examine 10-year, 20-year or longer past performance trends history suggests, though let’s be clear it cannot confirm, that volatility tends to be short-term. In fact long-term investing appears to increase your chances of returns. So, as we said in the first blog in this series , the best view on short-term volatility might be to simply look through it and remember your long-term goals.
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 is not a reliable indicator of future performance.