Keeping a cool head when stock markets are falling

Stephen Desmond
on

When the financial markets shift it has an impact on investors’ portfolios around the globe. At times like these, investing can feel like an emotional rollercoaster, especially if you’re new to the ups and downs of stock markets.

So, here’s what you do when stock markets are having a tough time: absolutely nothing.

A natural instinct is to sell, or move your investments, but, as history tells us, this can really damage your future returns. Standing firm and resisting the temptation to tinker with your portfolio as its value shifts – when it’s up, as well as when it’s down – is the cornerstone of successful long-term investing.

iStock-woman-office-meditation


Riding the turbulence

Investing is a journey. A long journey. And you need a cool head for the ride. The intention, of course, is that over time the value of your investments goes up and you enjoy healthy returns. But even if that’s the case, and hopefully it is, it’s highly unlikely you’ll see your returns go up in a straight line throughout that period. There will almost certainly be many peaks and troughs along the way. Just take a look at the FTSE 100 from 1985 by way of example:

FTSE 100 chart

The declines we’ve seen in UK stocks recently can cause uncertainty for some investors, but when viewed over a longer timeframe like this, such recent falls are barely visible. The key is to keep a long-term view and not over-react to short-term movements.

Human instinct         

For many years now, investors have commonly reacted to movements in their portfolio value in two ways – both very natural and understandable, but both potentially very damaging and costly as well:

  1. When markets go up, and an investor’s portfolio increases in value, they get excited and buy more.
  2. When markets go down, and an investor’s portfolio drops in value, they get depressed and sell to cut their losses.

This feels right. It’s our internal trigger, our mechanism for reacting to gain and loss, or ‘good’ and ‘bad’. But in investing terms, you could be much better off sticking to your guns, or even doing the complete opposite.

Research by Dalbar* in the US shows that the average investor’s 10-year return is around one third of pure stock market returns over the same period. That is, they would have been better leaving their investments in the stock market for that full 10 year period rather than switching out their investments from one area to another.

Going even further, when markets go down, this sometimes just as well represents an opportunity to ‘get in’ at a very good price, or, in other words add money to your investment portfolio. It may not feel like the best or most natural thing to do, but it could prove fruitful in the long run. Similarly, when markets go up, it may actually be that those investments have become over-valued and it is a good time to sell.

That said, it is extremely difficult to make that call. At Nutmeg, our investment team are constantly analysing global markets and economic data to determine whether a particular investment opportunity represents good value or not, but always with a long-term strategy in mind and not to seek out short-term profits by ‘timing the market’.

Timing the market

Ultimately, we believe it is futile trying to anticipate the best time to buy and sell individual company stocks. You might get lucky on some occasions but to do so consistently over a long period is nigh on impossible. Even when looking at the collective performance of a big bundle of stocks, as we do when we look at the value of the UK or US stock market, we believe the peaks and troughs are there to be ridden out with a long-term investment strategy.

Let’s take an example. The declines in the FTSE 100 in 2003 and 2008 were certainly dramatic. But the markets have generally-speaking recovered. Zooming in on the 2008 credit crisis we can see what happened to those investors who panicked and got out of their FTSE 100 investments at the wrong time.

FTSE 100 chart

At the start of 2008, markets were falling as the global crisis started to have a significant impact on stock markets. Many people no doubt succumbed to the fear and sold their investments in the FTSE 100 at the price of 5,500, thinking they should cut their losses. Over the next two months, the FTSE increased in value to 6,300. It may have looked like we were over the worst of it and investors wanting to ‘get back in’ to the FTSE had to do so at a much higher price.

Then, an even bigger fall in value, ultimately to 3,500 in March 2009. Again, anyone selling their investments at this time would have been cursing themselves just six months later as the FTSE bounced back up towards the 5,000 mark and they’d have a got lot less UK stocks for their money when they bought back in.

Seeing is believing

Anyone new to investing probably hasn’t had chance to build up experience of the big peaks and troughs in investment markets. As you go through these cycles and come out the other side, you come to realise they are all part of the normal investment journey, but until then it can feel quite scary.

But a quick look at the history books tells us just how common and sizeable these major market fluctuations can be. A ‘market correction’ (that is, a temporary decline in the value of global stocks) of 10% or more has occurred, on average, once per year between 1900 and 2010**. A 20% market correction comes on average every three and a half years. So, as you can see, they’re very common events.

If we look back to the credit crisis in 2008, there were record falls across global stock markets. Britain’s FTSE 100 had its worst year on record, down 31.3%, with similar declines in Paris and Frankfurt.

The economy and investments in stocks, particularly in the UK and US, have made good recoveries since then. Despite the negative news around stocks markets last year, the US stock market hit new highs in mid-September, after the FTSE 100 in the UK had risen to a 14-year high just a week earlier.

With dividends included, the UK market has produced a positive return in each of the years since 2008 but there have been the usual speed bumps to contend with along the way. In the UK we have experienced falls of at least 8 per cent over a four-week period in each of those years. Such drops will have perhaps panicked many investors in to selling at the time but, again, when viewed over a more realistic investment timeframe, they appear far less significant.

The power of dividends

As we’ve seen, when markets are tumbling, it’s easy to focus on the short-term declines and forget the bigger picture. It’s also easy to focus on the stock market prices alone and forget about the returns you can get in the form of dividends – that is, the income you can earn from the companies you own shares in.

In 2015, the FTSE 100 reached a new all-time high, but this only tells half of the story. If the dividends paid out by companies had been re-invested back in to the market, your FTSE value looks a lot higher.

FTSE 100 chart

What the experts do

Finally, a word from our Chief Investment Officer, Shaun Port, who has managed portfolios for central banks and public sector pensions schemes, responsible for over £2 billion in assets, and has experienced many ups and downs in financial markets during his 20 years of wealth management experience.

“The age-old investment philosophy of holding firm and resisting the urge to bail out is always tested in times of high volatility. Historically, investors who drastically alter their strategy when the market is low don’t perform as well as those who hold firm. For times like this, I believe it’s important to be diversified, to own a portfolio of investments, not just one fund, invest in overseas stocks as well as the UK, and consider other holdings such as bonds to reduce risk.”

Sources

* Dalbar research – https://rpseawright.wordpress.com/2014/04/28/how-advisors-can-make-better-decisions/

** http://financialalternatives.com/2012/frequency-of-market-corrections-test-your-knowledge/

Where not otherwise referenced, all data is from Macrobond, Bloomberg.

Risk warning

With investment, your capital is at risk. Past performance is not an indicator of future results.

Nutmeg® is a registered trade mark of Nutmeg Saving and Investment Limited, authorised and regulated by the Financial Conduct Authority, no. 552016, registered in England and Wales, no. 07503666, with a registered office at 5 New Street Square, London, EC4A 3TW.

Stephen Desmond

Stephen Desmond

Stephen regularly contributes to the Nutmegonomics blog - writing about investment and personal finance.

Other posts by