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Worried about the stock market? You need to read this

Posted on 11 March 2020 |

Financial Planning

You may have seen that the share market recently experienced a fluctuation in the wake of the continued spread of coronavirus and its impact on the global economy.

As the media continues to point to the recent volatility as a sign of troubling times to come, we just wanted to take the time to remind you how important it is not to panic in times like these.

As a member of the EQ Wealth community, your investment portfolio has been constructed according to the CARE Investment Philosophy and is designed with a long-term investment focus in mind. This focus means that, when correctly diversified, your portfolio is designed to weather any fluctuation that occurs in the market with confidence.

There are 3 main ways that investors lose money during times of uncertainty in the market. These include:

  • Panicking and selling: this happens when uneducated investors don’t understand how markets react or how they recover in the long term.
  • Being forced to sell investments: this may happen when you don’t have, or have not planned to have enough, reserves or liquidity to ride out the storms of down markets.
  • Not having a diverse portfolio: diversification ensures you are invested across multiple companies, reducing your exposure to individual company risk. CARE Investment Portfolios are structured to provide you with massive diversification as they are designed to prevent investors from putting all their eggs in one basket and hoping for the best.

The CARE Investment Philosophy, combined with your expert team of investment advisors, was designed to combat all of these ways that investors may potentially lose money.
In an environment like the current market, we believe that there are 8 ways investors can MESS IT UP and endanger the success of their investment portfolios:

  • Media: don’t let the media become your financial advisor. The media understands you are four times more likely to act out of fear to protect yourself than because of greed. The next time you hear a negative media story about the share market think to yourself ‘how often do you hear a good story about the share market where everyone made money and the market went up?’. The reality is that positive stories and up markets don’t sell newspapers, and this is why they are rarely told. So it is important that you are consciously aware to not get caught up in the hype of the bad news story of the day when it happens.
  • Emotions: good investment choices must be made with a clear mind. The best advice we can give you when it comes to investing is this: always make logical, calm, calculated investment decisions with both a long term and short term perspective and never make an investment decision solely based on your emotions or a reaction to a market drop or market increase.
  • Short-term focus: a focus that is short-term can be extremely expensive in the long-term. We don’t focus on what’s hot in the stock market right now or the short term; instead, we focus on where your investments are going to end up in the future.
  • Single-issue obsessions: losing sight of the bigger picture can be your biggest enemy. Many investors get caught up on one issue and how this will affect the whole world. It’s always important to have perspective and to assess each individual issue and consider whether it may or may not have relevance in the grand scheme of things.
  • Illiquidity: not having enough cash reserves makes you vulnerable. Suddenly selling down shares to obtain cash creates what is called a sequencing risk. Sequencing risk is also known as the reverse effect of dollar cost averaging. That’s why the CARE Investment Philosophy advocates having at least four years of cash reserves in retirement for when the markets drop. This will eliminate the need to sell shares in down markets and reduce the impacts of sequencing risk to your portfolio.
  • Timing and Selection: investors may think they can but NOBODY can successfully time the market. Our view is that anytime is a good time, as we use a strategy called dollar cost averaging where you invest into the market little by little. If the market is going down you are buying shares at a cheaper price and if the market is going up, you are not paying as much on the way up.
  • Under-diversification: a successful investment portfolio is a diversified investment portfolio. Having a diversified portfolio across many different companies simultaneously is a good strategy. If, for example, one company fails and 299 do well then the investor has gained overall and is in a less vulnerable position than if they invested only in the one company that failed.
  • Performance: a focus on market performance is massively misguided. The old school market proposition of picking stocks or investment managers who consistently out-perform the market is not a real or sustainable value proposition. Consistent market out-performance is largely non-existent and can lead to Dalbar-type behaviour when the markets drop and investors panic and sell.

In fact, making a rash decision based on fear may be one of the worst things you can do to the success of your investment portfolio.

Consider this table, sourced from Tony Robbins’ book Unshakeable, which shows the worst share market corrections in recent history and how much they recovered over the following 12 months:

If you had decided to pull out of the market and sit on the sidelines in any of those periods it may have had a significant impact on the success of your portfolio if you had missed the trading days that saw the most growth.

As Rob McGregor, the founder of the CARE Investment Philosophy, puts it: market volatility isn’t something to fear. Instead, it provides a golden opportunity to grow your portfolio even further as you continue on your journey to financial freedom.

This idea is explained further in what is known as the Dalbar Study, a study that is fundamental to the CARE Investment Philosophy. Originally conducted between 1980 and 2000 in the USA on the top 500 US listed companies, the original Dalbar Study found that the average return over a 20 year period for those same companies was 12%, which is a very good average return.

Do you know what the return was for investors in the US market over the same period? It was around 4%.

And the number one reason for the 8% difference was bad investor behaviour.

The chart below details the emotional rollercoaster that investors experience when the market fluctuates:

So what happens when markets are down?

When investments markets are down, we often have the media striking fear into the investment world, prompting bad investor behaviour where uneducated investors sell out of the market by turning their shares into cash at the lowest point. When the market starts to look good again and is going up, these same investors buy back into the market when share prices are high, missing the opportunity to purchase shares while prices are low.

Due to this bad investor behaviour, shares are sold when they should not have been sold and bought when they should not have been bought. This is exactly how investors sacrifice 5-8% of their investment portfolios every year and shows how the Dalbar cycle of bad behaviour can impact on the success of your investment portfolio.

And that’s why panicking during a period of market volatility is one of the worst things you can do.

As always, if you have any questions or concerns on how the recent volatility may affect you personally, please don’t hesitate to get in touch.

As your team of dedicated financial experts, we’re here to help.

Until next time, to your financial success!

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