Why choosing not to change portfolios is an active decision

James McManus


2 min read

 

You will often hear investment professionals talk about the importance of remaining invested through turbulent markets, ignoring the ‘market noise’, and focusing on the long-term goals for which you are investing. But why is this?

Calm man looking out

At times of market downturns, when there is a lot of noise about low points, it can be difficult to focus on the long-term investment outlook. The following charts show the annual return an investor would have received if they had remained invested in UK or US equity markets for the entire calendar year , for each year between 1990 and 2017. The charts also show the maximum drawdown for these markets in each calendar year – in other words the difference between the peak and the trough in returns, or the highest possible loss investors could have incurred during the year .

The dots marked on the charts show that in each calendar year there were periods where markets had significant declines, yet the bars show that had investors remained invested for the whole year they typically would have experienced positive returns. This demonstrates the importance of looking beyond short-term market moves in pursuit of long-term goals – selling at any of these low points could have resulted in investors being significantly worse off.

 

The two charts also show that volatility is a natural part of investing – even in the best years for market returns, there have been periods where the market experienced negative performance. Selling an investment, or similarly de-risking a portfolio, would have served to lock in this loss and potentially move investors further from their investing goal, especially when compound returns are taken into consideration. History tells us that markets do recover short term losses, and thus investors are better off remaining invested for the long term.

In the UK stock market (FTSE 100) going back to 1990, there have been 19 years that returned positive full year returns. However, in 17 of those 19 years this was despite a drawdown of 5% or more during the year. Similarly, the US stock market (MSCI USA) had 23 years with positive calendar year returns between 1990 and 2017, 21 of which were despite a drawdown of 5% or more within the year.

Professional investors are aware of these facts, which is why they often don’t make changes to portfolios during periods of market turbulence if they can avoid it. However, inactivity doesn’t mean they are taking an inactive approach to portfolio management.

At Nutmeg, for example, our investment team continually reviews macro-economic and market data to ensure portfolios are positioned appropriately for our expectations of the road ahead. Our investment approach is to focus on the fundamentals of the global economy rather than just short-term market moves largely driven by sentiment.

Should the fundamental outlook change, our investment team will act to re-position portfolios. However sometimes the best action one can take in a period of volatility is to remain invested, and our team may choose, having reviewed portfolios, to make no changes.

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.

Sources:

Macrobond, MSCI, FTSE. 01/01/1990 to 31/12/2017.

Annual returns include dividends reinvested, but does not account for fees

Drawdown does not account for dividends

James McManus

James McManus

A self-confessed ETF geek, James is head of ETF research at Nutmeg. He joined in 2015 from Coutts & Co, where he was an associate director in the investment office. James holds a Bsc (Hons) in International Business from Nottingham Business School.


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