Before you hit the panic button take a deep breath.
Can you think of what one of the greatest challenges an everyday, long term investor has to overcome? Sometimes an investor’s greatest obstacle to success is themselves.
It’s true. If you know the saying, ‘Sometimes you are your own worst enemy’, it can often apply here. Investors panic when markets drop.
You can hardly blame them. It is human nature to avoid negative and seek positive, and watching markets drop leaves negative feelings. It can make you feel sick when your hard earned investment goes from $10,000 to $9,000 and this is when the anxiety sets in.
While instinct may be to cut your losses and get out of the market, this is quite often the very opposite of what you should do, provided you have time on your side. So just before you jump off that ledge there are a few things to consider.
First of all, it can be helpful to look at what history has taught us about periods of market volatility. History tells us that patient, long term investors reap the rewards. If you can look beyond the initial loss and remember that time is on your side, you can see proof that the down times won’t last forever.
In fact, as counter-intuitive as it might seem on the onset, sometimes adding another lump sum to your initial investment is one of the best strategies. In this scenario, you are buying low and therefore reducing your average cost per unit or share in your investment. Another strategy to consider is adding a monthly investment to your plan to continue to get benefits from the market downturn by buying your units at a lower price. Both of these strategies are using the market drop to your advantage. Some people might be surprised to hear that more sophisticated investors get excited during market lows as it might be their opportunity to buy something at an undervalued price.
Market volatility is nothing new. If you look at the last 25 years each market downturn later posted significant recovery and positive returns in the two year periods that followed each of these market drops. Investors who stayed the course not only recovered, but came significantly ahead of those who didn’t.
Sometimes investors feel they have enough experience or information to jump in and out of the market and do a better job but this is seldom the case. You need to ride out the lows in order to be sitting in the right place at the right time when the market starts to move up. Missing out on those days can be detrimental, so staying put is usually a good strategy.
Invesco Canada Ltd has published a great snapshot to illustrate how missing the 20 best days could cut your return by 10%:
If you had hypothetically invested $10,000 in the S&P/TSX Composite Index on January 30, 2004, over 10 years your $10,000 would have grown to $20,922 – an average annual total compound return of 7.66%. But suppose that during that period there were times when you decided to get out of the market and , as a result, you missed the market’s 10 best single-day performances over this 10 year period (remember, this is just 10 out of a total 2,515 business days). In this case, your 7.66% return would have fallen to 1.31%. If you had missed the market’s 20 best days (again, just 20 out of a total of 2,515 business days) that 7.66% return would have dropped to -2.52%.
Invesco Canada Ltd., 2014.
If you are an investor with time on your side, take these strategies into consideration and keep this in mind when the market fluctuates. Before you hit the panic button, take a deep breath and look at the historical lessons in market volatility. Sometimes we have before us an opportunity in disguise.
Stephanie Farrow, B.A., CFP., Stephanie has over 20 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning, and Certified Financial Planner designation. Stephanie has been writing a financial planning column for the local business magazine Elgin This Month since 2010 and hosts our Farrow Financial Blog and Twitter @farrowfinancial. Stephanie and her husband Ken Farrow own Farrow Financial Services Inc., are busy raising three young children and actively involved in the community. Our Farrow Financial Services Team.