INSIGHT: Keep your head when all about you are losing theirs

March 10, 2020

("Keep your head when all about you are losing theirs" - Rudyard Kipling)

The sharp drop in global equity markets has investors on edge, one might even go so far as to say ‘fearful’. Rarely does fear help us prevail in an adverse situation. Indeed we often hold in high regard our peers who show the discipline to take a step back, assess the situation objectively and offer a considered path to overcoming what at first appeared as an insurmountable hurdle. Investing is no different and it is important to build this resilience into your investment process.

Recent market declines have some investors wondering if they should move to cash in case markets drop further. History has shown that this is a poor strategy for a long-term investor – it is far better to stick with a well-diversified portfolio than to try to precisely time the exit and entry points into gyrating markets. What works is to maintain an investment discipline over time even if you begin investing at the worst time possible, at the top of the market.

Let us say you are the unluckiest investor in the world. You come into money and decide to invest in a well-diversified portfolio (2% cash, 22% bonds, 51% global equities, 25% credit/hybrid). However, you unknowingly do so at the absolutely worst times possible in the last sixty years, meaning immediately prior to the onset of the nine worst markets in that period (including Black Monday, the dot-com implosion, and the 2008 Global Financial Crisis).

Undoubtedly you would feel terribly unlucky in the near term and would question your strategy (and perhaps your sanity!). But what if you stay the course and remain invested for the next five years?

The results are noteworthy. In all nine periods your portfolio made money despite its poor start, with an average gain of 32% over the five-year period. The average drawdown was 14% (unpleasant but hardly disastrous) and it took an average of only 6.4 months from peak drawdown to regain all the initial losses.

Remaining invested and consistently rebalancing on a monthly basis led to perfectly acceptable returns in every worst-case starting scenario. It is of course true that returns could have been better if you’d had the foresight to sell before the drop and buy at the bottom however the ability to time markets has proven to be virtually impossible for even the most astute investor, particularly when this would require the ability to accurately do so twice: first to know when to sell, and second to know when to buy back in.

The implications of this are clear:

  • Investors are overly concerned with market drawdowns which inevitably happen.
  • Sticking to a well-structured investment discipline works, even (or particularly) in difficult times.
  • It’s more important in the long run to be invested than to try to time when to be invested.

If volatility isn’t the enemy of the long-term investor, what is? The permanent loss of capital due to the realization of losses. While that’s an entire subject in itself, here are the primary causes of permanent losses and ways to avoid them from occurring:

  • Insufficient Liquidity. Lack of the liquidity needed to fund lifestyle and other obligations can create the need for forced assets sales during down markets. Hold sufficient liquidity to get you through 12-18 months of needs.
  • Bad Investments. This can be caused by a lack of due diligence on the fundamentals driving returns and risks, poor security selection, impulsive behaviour and/or poor trade execution. Investing steadily through the cycle (e.g. “dollar cost averaging”) is a simple technique to build wealth over time.
  • Overpaying for assets. Ensure that the risk versus reward ratio of your investments is balanced and rebalance your portfolio regularly.
  • Compromising on quality. Good investments are not those delivering high returns by sacrificing quality. Attractive investments balance risk and reward but also increase the robustness of your portfolio (diversification) and reduce the downside risk whilst maintaining participation in growth (convexity). Accessing and identifying such investments may require employing the expertise of others.

Tiedemann Constantia (Tiedemann) is an investment advisor. Information given herein is believed to be reliable, but Tiedemann does not warrant its completeness or accuracy. Economic and market forecasts and opinions and estimates constitute our judgment and are subject to change without notice. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Any references to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. Past performance is no guarantee of future results. Investors should consult with their financial advisors before investing in any investments. This is for information purposes only and is not a solicitation to buy or sell any specific investment.

Find out what our expertise can do for you and your goals.
Get the latest news and insights.