When markets fall, it's natural to want to take action to prevent further losses. Doing so however can do more harm than good. Here's why timing the market to buy low and sell high is not as easy as it sounds.
If you’re invested in the financial markets and also keeping up with the news, you’re probably wondering if you should do anything to insulate your portfolio from incurring further losses alongside rising interest rates and inflation.
In times like these, we at Vanguard are very fond of reminding investors to “maintain discipline” and “stay the course” – in other words, stay invested. But here’s why:
Reacting to the here and now
Most market commentary are about the events of the day, with a focus on the here and now. However, the ‘today’ is not as significant to financial markets as they’re generally forward looking and more concerned about what will happen in the future. Thus, using daily developments to make constant adjustments to your portfolio is unlikely to help you accumulate wealth over the long term as the market will have already priced it in.
Additionally, to successfully time the market, investors need to get all five of these investment factors right including precisely timing exit and re-entry – a near impossible feat for even the most experienced of investors.
Locking in your losses
When markets fall, it’s natural to want to sell riskier assets (i.e. equities) and move to cash or safer assets like government securities. But exiting the share market now means locking in your losses permanently and not giving your portfolio the opportunity to benefit when markets recover. Vanguard research found that 80 per cent of investors who panicked and moved to cash during the 2020 sell off would have been better off if they had stayed invested.
Investing at the peak
While we all want to “buy low and sell high” so our portfolios can outperform the market average, in reality, it is extremely hard to execute perfectly every single time. Vanguard analysis of the last 5 decades reveals that even in the worst-case scenarios - where investors bought into the market at its peak, just before a dip – as long as investors stayed invested instead of moving to cash, they still benefited from positive annual returns of almost 11%.
If the recent market volatility is keeping you up at night, take a moment to reflect on whether your emotions are short-term reactions to the current conditions, or something you really need to act on. If you feel like you cannot stomach temporary losses, consider if your asset allocation is right for your overall investment goals and risk appetite.
A well-diversified core portfolio, aligned to your risk appetite will help spread your risk and afford you a margin of safety over the long term. Get this right and you will probably sleep better at night.