We'd all love for the market to go on a tear forever, reaching record highs and blowing minds; but the truth is, downturns are a reality, particularly if you are a long-term investor.
The fact that downturns are inevitable can be scary. And off-putting, to be quite honest. Add to this that we have no idea when the next downturn is coming or how long it will last. Anyone who says they can predict a market downturn is…um…overconfident. (That said we do build downturns into our forecasts...more on this below).
That's why when the market throws you for a loop — as with most unnerving situations — you're better off by not panicking and sticking to an actual plan instead. One that doesn't consist of selling everything immediately in an attempt to cut your losses. Because if history has taught us anything, it's that staying the course may be the best way to make it through a downturn.
And it's easier to do than you may think.
Over the past 90 years, the stock market has trended upward, having returned around 9.5 per cent on average annually. But it's had its share of downturns along the way as well.
Okay, so what happens when you find yourself caught in a serious downturn? How long has it taken to recover from a tough market? While it depends on the downturn, how you react may also affect your recovery.
A better strategy
We all remember the stock market decline of 2007 and 2008. Pretty horrific markets with frightening headlines, you'll recall. Believe me, I remember very well.
But, according to the global investment research company Morningstar's "The Importance of Staying Invested", if you invested $100,000 in the stock market at the beginning of 2007 and didn't touch it (no investing more money and no selling), you would have $195,000 at the beginning of 2017. So, despite staying in the market through one of the worst downturns in history, you still ended up making money.
But if you sold everything when the market hit bottom (in January of 2009) and stayed on the side lines in cash, you would have ended that same 10-year period with just about $55,000. The kicker: That's more than $140,000 less than what you would have had if you just left it alone.
Ouch. So, selling — which certainly felt like a relief at the time — turned out to be a losing strategy.
But that's not all.
You could have recovered even faster had you continued to invest through the downturn of 2007 and 2008. Research shows that if you invested $1000 in the S&P 500 at the beginning of 2008 and another $1000 at the beginning of 2009, you were back in positive territory at the end of 2009.
Helping you out
Here's what we do to help our clients navigate the inevitable equity market downturns:
* We design investment portfolios that are globally diversified and not just invested in stocks. Diversification helps lower portfolios' overall risk, so investors will take on even less risk than the equity-only scenarios.
The composition of our portfolios range anywhere from a low equity allocation for shorter-term goals like a home goal, with say a six-year time horizon, to a high — up to 97 per cent — for a longer-term goal like retirement (depending on your timeline).
That's because the increased risk associated with equities may give you the opportunity for increased returns over your goal timeline. And the thinking is that with a longer timeline, you may have more time to recover in the event of a downturn... so you can likely afford a greater level of risk.
* Investment portfolio are rebalanced whenever the asset allocation, or mix of investments, gets off-kilter. So, if a downturn throws off portfolio's asset allocation, we'll rebalance it to make sure that it is never concentrated in one type of investment.
* Last but certainly not least: We encourage investors to set up auto deposits (This a good kind of "setting and forgetting"). This can serve to take the emotion out of investing, which can make it less likely that you panic. On top of that, you're investing regularly, which might be one of the best gifts an investor can give to herself.
Downturns aren't pretty, and it's likely that you'll encounter some over your investing life. But remember: History has shown us that downturns come with an expiration date, and the market has tended to rebound. That's why staying invested in the market — as hard as that can be — is often viewed as a winning strategy. It just takes some time.
* Nick Stewart is the CEO and an Authorised Financial Adviser at Stewart Group – a Hawke's Bay-based independent financial advisory firm based in Hastings.
* The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961.