STAYING THE COURSE

THE VALUE OF RATIONALITY DURING MARKET TURBULENCE

April 3, 2018

Charles Dickens begins A Tale of Two Cities with the words “It was the best of times. It was the worst of times.” He might have been addressing the current status of equity markets right around the globe.

Indeed, during recent months, newspaper headlines have been screaming (almost at the same time) about market “meltdowns” and “the biggest up-day in history.” The Dow Jones Industrial Average has moved both up and down by hundreds of points on a daily basis.

This is short-term volatility seldom encountered in the past. And while such wild gyrations can certainly be unnerving, what is worrisome is the fact that many market participants have begun their investment programs subsequent to the last major market decline. In short, they’ve never personally experienced what’s happening now, nor have they ever weathered the storm of severe volatility.

As I’ve mentioned in the past before and what must continue to be emphasized – is the fact that, like it or not, the laws of gravity apply in capital markets as they do in nature. Equity values do rise over the long term. But stock prices don’t rise in a straight line. As a look at any long-term price chart will demonstrate, there are valleys as well as peaks.

So the issue now is not one of whether there will be a significant decline in equity markets. History tells us that such is a fact of life. The question of real importance is: How intelligent and prudent will our response be?

As with any other strategy that is developed and practiced in contemplation of a possible future emergency, planning ahead for a down market will leave you well prepared when the time to act (or, indeed, not act) is at hand.

There are some key points to keep in mind, and I would like to discuss each one of them in some detail.

Understand Your Limitations

Make no mistake about it, knowledge is power. This is especially true when it comes to investments and investing. Another adage to keep in mind here is “a little knowledge is a dangerous thing.” Let me add that, in this environment, it can be a very dangerous thing.

In my view, far too many individuals think they’re “sophisticated” investors. In fact, too much of a focus on the day-to-day and week-to-week reviews favoured by the media can be quite counterproductive. Too often, you simply can’t see the forest for the trees.

While there is absolutely no question that the more you understand about markets, the economy, particular investment vehicles and financial issues in general, the better your decisions will be, you also need to make sure that you have a realistic appreciation of just how much you do know – you have to know your limitations.

The most important item here is knowing that your decisions are based on fact, rather than on myth.

Don’t Go It Alone

It is generally beneficial to build and maintain a relationship with a good professional advisor (whether we’re talking about investing or many other endeavors). In seeking out an advisor, keep in mind that competence and expertise are of course necessary, but they’re not sufficient. The best advisors have the ability and the willingness to convey a level of understanding (and of comfort) to their clients that results in the client more likely than not making sound, considered and rational decisions.

It is suggested that it is only with this sort of advisor that a rewarding long-term relationship can be established. This level of relationship can mean the difference between hanging in when times are tough or bailing out at an inopportune time and never getting back in.

Without a Strategy, Tactics Aren’t Worth Much

Making tactical investment decisions in a strategic vacuum is not a good approach, and it’s certainly not one that’s likely to reward you with success. The important thing here is not what the strategy is, per se, but rather that it is appropriate in your unique circumstances, that you genuinely understand it, and that it makes sense to you.

Without that level of comfort with your approach it is unlikely that, when the crunch comes, you’ll stay committed to the plan. Let’s face it, it’s virtually impossible to develop a sensible investment strategy at the spur of the moment, in a reactionary way. Being proactive will allow you to formulate your plan in a thoughtful, considered manner.

History has demonstrated that buying and holding is a better investment strategy than is market timing. With respect to mutual funds, (and it’s likely that the same is true in the case of individual stock holdings), research has shown that, in general, funds do much better than their unit holders do. More to the point, the more individuals “do their own thing” the more likely it is that they’ll under-perform the funds they purchase. Why? They tend to trade in and out of positions – all too often buying near highs and selling near lows. The result is not only diminished market returns, but also transaction costs, and often tax inefficiencies.

Diversification, Risk and Reward

Generally speaking, a truly diversified investment portfolio involves less risk than a more concentrated one. Unfortunately, many investors today believe just the opposite – or at least as far as domestic versus international investing is concerned. Even though Canada accounts for less than 3% of world market capitalization, not many Canadians have made much by way of allocation to international equities. Why? It’s difficult to say for sure, but it’s suggested that the most compelling reason is a lack of understanding of foreign markets, and therefore a reluctance to invest there.

One strategy that all investors ought to consider at this point is taking whatever steps may be necessary to become truly diversified. In this regard, please note that merely increasing the number of positions that you have will not necessarily give you more diversification (although it certainly will give you more complexity and probably more confusion as well!).

Needless to say, based on the comments just made, diversification in terms of geography is very important. As well, make sure that, if you are holding mutual funds, the managers of your funds are not merely clones of each other. Diversification of management style can be just as important as global diversification (perhaps even more so). This is an area where a good relationship with a professional advisor would be especially valuable. If such a relationship is not in place, you might have to do a great deal of research on your own.

Whatever the case, though, diversification is an important consideration; and it’s one that many investors have not dealt with.

Learning from History

For quite a while now, many financial advisors have been cautioning their clients (often, it is feared, in vain) to temper the unrealistic expectations that they’ve formed, based on above average returns over the last number of years. The problem is that, even with respect to investors who have weathered the storm before, perspective has been lost because those storms have faded into the distant past.

The fact of the matter is, market declines occur on a regular basis, and will continue to do so in the future. If history is any guide, we can expect a decline of at least 20% every seven years on average.

Keep Your Cool

As I’ve mentioned before, the word “panic” is one that’s often associated with severe market declines. But, just as any other emergency in which you have the misfortune to find yourself, your chances of success are inversely proportional to your level of panic.

It’s obvious, though, that without discipline you could well find yourself getting into and out of the market at the wrong times. The best investment strategy over the long term is to buy and hold, it’s not easy to stay the course in the face of severely volatile markets – unless you’ve adopted a strategy that you truly believe in.

Howard Goodman
President, HG Partners Limited
Director, Private Client Group &
Senior Financial Advisor,
HollisWealth

This article was prepared solely by Howard Goodman who is a registered representative of HollisWealth® a trade name of Investia Financial Services Inc. (a member of the Mutual Fund Dealers Association of Canada and the MFDA Investor Protection Corporation). The views and opinions, including any recommendations, expressed in this article are those of Howard Goodman alone and they are not those of HollisWealth®

HG Partners Limited is an independent company. iA Financial Group and Industrial Alliance companies have no liability for activities outside of HollisWealth®