At times when market volatility increases, it is important that you do not make knee jerk decisions. Its why we all need reminding, that making bad decisions can compound the problem. To this end we talked to Dimensional about navigating volatile markets.
Dimensional was founded 37 years ago, as a firm they manage $582B with offices in 9 different countries, employing over 1,200 people. You can read more about Dimensional here.
Dimensional reminded us that after a period of relative calm in the markets, in recent days the increase in volatility in the stock market has resulted in renewed anxiety for many investors.
While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
Intra-year declines
Exhibit 1 shows calendar year returns for the US stock market, the world's biggest, since 1979, as well as the largest intra-year declines that occurred during a given year. During this period, the average intra-year decline was about 14%. About half of the years observed had declines of more than 10%, and around a third had declines of more than 15%. Despite substantial intra-year drops, calendar year returns were positive in 32 years out of the 37 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.
Reacting impacts performance
If one was to try and time the market in order to avoid the potential losses associated with periods of increased volatility, would this help or hinder long-term performance? If current market prices aggregate the information and expectations of market participants, stock mispricing cannot be systematically exploited through market timing. In other words, it is unlikely that investors can successfully time the market, and if they do manage it, it may be a result of luck rather than skill. Further complicating the prospect of market timing being additive to portfolio performance is the fact that a substantial proportion of the total return of stocks over long periods comes from just a handful of days. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, the prudent course is likely to remain invested during periods of volatility rather than jump in and out of stocks. Otherwise, an investor runs the risk of being on the sidelines on days when returns happen to be strongly positive.
Exhibit 2 helps illustrate this point. It shows the annualised compound return of the S&P 500 Index going back to 1990 and illustrates the impact of missing out on just a few days of strong returns. The bars represent the hypothetical growth of $1,000 over the period and show what happened if you missed the best single day during the period and what happened if you missed a handful of the best single days. The data shows that being on the sidelines for only a few of the best single days in the market would have resulted in substantially lower returns than the total period had to offer.
Conclusion
While market volatility can be nerve-racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines could prove more harmful than helpful. By adhering to a well-thought-out investment plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.
At Dimensional, they believe that the right financial adviser plays a vital role in helping you understand what you can control while providing the expertise, perspective, and encouragement to keep you focused on your destination.
In 2017, Dimensional conducted an investor feedback survey on behalf of advisers who work with our firm. The findings show that investors place a high value on the sense of security they receive from their financial adviser relationships.
Take at look at the video below which we hope highlights one of our core investment beliefs, have a plan, stick to it and tune out the noise.
Source: Dimensional Fund Advisors LP.
The views and opinions expressed in this article are those of the author and not necessarily those of Dimensional Fund Advisors Ltd. (DFAL). DFAL accepts no liability over the content or arising from use of this material. The information in this material is provided for background information only. It does not constitute investment advice, recommendation or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. To this end you should seek professional advice before acting on its contents.
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