Down markets are inevitable, both as part of the normal cycle and due to specific events. Studies show that investors who panic and react to these market events often underperform. As investors we need to be prepared both mentally and in terms of our financial strategies so that we can remain calm and avoid costly mistakes.
Investor returns versus investment returns
A study by Morningstar compared the returns of individual investors to those of the investment vehicles they invested in. The study looked at these differences among seven asset classes over a ten-year time frame ending in mid-2013 and found the following:
- A consistent 2.5 percentage point difference over this time frame between the returns earned by investors and those earned by investments in these seven asset classes.
- This difference was consistent across all of the asset classes studied, both domestic and foreign equities, balanced funds, fixed income and sector funds.
The main reason for this discrepancy was investor behavior. Many investors panicked and sold when the markets got dicey during the financial crisis of 2008-2009. Many of these investors remained out of the market when things turned up and missed some or all of the rally that began in March of 2009.
Other studies, such as one by the research firm Dalbar, have shown a similar relationship between investor and investment returns. This study showed a 20-year investor return of 5.02% for investors versus 9.22% for the comparable indices.
Fear is normal
Fear is a normal reaction to extreme market downturns. During the financial crisis it was scary some days for us as financial advisors to turn on our computers and look at the impact on the markets and more importantly on our client’s portfolios. We know this was even more unpleasant for our clients.
How you as investors react to that fear is critical to your success in achieving your financial objectives.
The first half of 2016 was a dicey and volatile time for the markets. By the end of February, the S&P 500 Index had lost 5.5% of its value compared with the end of 2015. But by the end of March, the index was up 0.4% from the end of the year and recorded a 6.2% gain in the month of March.
Fast forward to late June and the Dow Jones Industrial Average fell by 610 points on June 24 in the wake of the Brexit vote. But by the end of June the S&P 500 was up 2.7% for the year and 8.6% since the end of February.
Investors who panicked and sold during the low points of the year or during the Brexit drop missed out on some rather decent gains and are likely worse off for having done so.
Planning is key
You can’t control what will happen in the financial markets or the economy and neither can we. You can control how you invest, the way in which your investments are allocated, and the level of investment risk that you assume. This is the focus of the financial planning we do for you and the investment strategies that are an outgrowth of this planning. To us the planning process and the ongoing monitoring and periodic revisions of your plan are the cornerstones of the service we provide.
Please reach out to us if you have any concerns, especially in the face of a falling stock market. We will review your investments with you again so that you can be certain they are aligned with your goals. When you are confident that you are invested appropriately for your situation, it's easier to stay the course - which is often the best thing you can do.