During my 25 years in business, I have seen many ups and downs in the stockmarket. It can be a volatile place with many factors influencing pricing. For anyone who is anxious when they see a downward dip, there are a number of key considerations for all investors that I feel are appropriate to any given situation.
You might know it’s coming but you have no idea how the market will react
You can never be sure how a single event will impact stock prices. There are many factors influencing pricing on an ongoing basis. Although major events and stock market movements may be related, it can be challenging to determine correlations. Also, after good or bad news, stock prices may not move in the direction investors expect. It’s not enough to identify major events in advance; you also must accurately predict how markets will react.
Reacting to a crisis by leaving the market can cost you dearly
When investors move in or out of the market in response to an event, they are predicting when the market will have a positive or negative return. We believe markets incorporate all available information. Thus, once information related to the event is known by investors, prices have already adjusted.
In addition, if you flee the market after a major crisis, you must then decide when to return to stocks. In many cases, the decision to reinvest comes after a rebound has begun, resulting in missed opportunities. Moving in and out of the market may also incur additional costs and have potential tax implications for investors.
Dealing with the uncertainty associated with major events is one reason why investors earn a return over time
If there were no uncertainty regarding future events and the impact on stock prices, why would investors earn a return greater than bank deposits or government bonds (known at the risk-free rate)? While major events and their unknown impact on stock prices create uncertainty for investors, the uncertainty is a major reason why investors earn a return.
Investors are better prepared to apply discipline during a crisis if they have realistic expectations, take a long-term view of markets, and understand why some investments have higher expected returns.
Responding to the latest news and exiting the market may cause more anxiety
Markets fluctuate daily in response to news, and sometimes they experience significant declines. This can create anxiety for investors. However, exiting the market and then watching a subsequent rebound in stock prices can be just as unnerving. In this case, the stress of being in the market is replaced by the stress of being out of the market.
Also, the perceived significance of major events may not align with realized investment returns. Adjusting your portfolio frequently in response to negative news introduces stress in many ways. This can affect your overall investment experience.
Diversification is key
Proper diversification, prudent investment management, and a goals-driven asset allocation can help investors endure a market downturn.
An investment manager can monitor global events and the potential impact on the portfolio management process, such as changes in liquidity, to make decisions that may benefit investors.
In addition, other asset classes, including fixed income, can help minimize the overall volatility and price impact on a total portfolio. Having an understandable strategy that accounts for market declines can help you look past daily news and focus on the long-term.
At the end of the day, the important thing is to set your goals. Keep what you want to achieve in mind and allow the markets do what they do!
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