When it comes to investing in unpredictable times it helps to have a few well-respected rules of thumb to fall back on for reassurance. Head of Defined Contribution and Wealth Advisor Services in the US, Matt Sommer, offers his own time-tested thoughts to help investors navigate these challenges and make informed decisions regarding their portfolios.
Investors are facing two significant challenges right now: stock market volatility and high inflation. While being felt acutely in the US, this is of course a global phenomenon.
On 9 May global stocks suffered their worst one-day decline since the early days of the pandemic. The FTSE All-World barometer of global stocks dropped 3 per cent and hit its lowest level since December 2020.1 This reflected concerns over slowdowns in the world’s largest economies at the same time as central banks are paring back support and inflation in the US remains elevated at around its highest level for 40 years.2
The good news is, there are some well-respected investing rules of thumb that can offer reassurance in any market or economic environment. Following are some time-tested thoughts to help investors navigate today’s challenges and make informed decisions regarding their portfolios.
Stock market corrections are normal
A stock market correction is defined as a decline in stock prices of at least 10% from the previous high. While declines like this may be unnerving to many investors, there is some good news. First, since 1946 there have been 29 occurrences where the S&P 500 Index of US stocks declined between 10% and 20%. In these cases, the average time to recover these losses was only four months. Second, while market drops of at least 10% are common, market drops of 20% or more are not. There have been nine occurrences of declines of between 20% and 40%, and only three occurrences of a decline greater than 40%.
While there are no guarantees that these observations will be repeated, long-term investors may find peace of mind in knowing that the historical record has worked in their favour.
Time in the market, not market timing
In uncertain markets, it’s important for long-term investors to maintain perspective. This includes avoiding the market-timing trap. Attempting to time the market is considered a trap because long-term returns have historically been attributable to a relatively small number of trading days. Being out of the market on these days could dramatically reduce returns over time and may even result in losses.
As an example, consider a US$10,000 investment in the S&P 500 from 1999 through 2021. If the money was fully invested during the entire period, the ending value would be US$59,799. On the other hand, if the 10 best days of the market were missed over this 22-year period, the ending value of the original investment would be roughly half (US$27,398). What’s more, if the 40 best days were missed, the investor would have incurred a loss of approximately US$4,000.3 Therefore, to successfully time the market, investors have to be right twice: knowing when to buy and when to sell. Exchange rates will also have an impact when investing outside of an investor’s domestic market.
Declining stock prices may actually be beneficial
A temporary decline in stock market prices may provide long-term investors certain benefits. Adopting a cost averaging approach (regular monthly investments), more shares are being purchased on market dips (although this may also be influenced by exchange rates), thus lowering a participant’s average cost. The lower the average cost, the easier it may be to experience gains over time. Additionally, some investors may be able to utilise losses incurred to offset any potential capital gains.
Higher interest rates may require repositioning of bond investments
It is widely expected that the US Federal Reserve (and a number of other central banks globally) will continue to slowly raise short-term interest rates. Because bond prices generally move in the opposite direction of interest rates, some investors may be questioning the wisdom of continuing to hold these investments. In similar circumstances in the past, some investors have considered holding at least a portion of their portfolio in bonds because bonds – particularly those from highly rated creditors – can help provide capital preservation and buoy a portfolio’s value during times of crisis and extreme market volatility.
Arguably, a key aspect to holding bonds in this environment, however, is to manage duration, which is a measure of a bond value’s sensitivity to interest rate changes. Generally, in a rising interest rate environment, many investors prefer short-duration bonds, which are less sensitive to rate changes than long-duration bonds. Another factor to consider is that some bonds pay a floating interest rate. Unlike a bond that pays a fixed coupon, the yield paid on a floating-rate security will fluctuate in tandem with the general interest rate environment.
Considerations to potentially keep up with inflation
Beyond long-term investments, such as stocks and bonds, many investors are feeling the adverse effects of inflation in their everyday lives. In the US, for example, the latest consumer price index figures rose by 8.3% in April from a year ago, remaining close to a 40-year high.2 While wages have also increased, they have not kept pace with rising prices. Although these statistics are US focused, rising energy and food costs are a global issue. For some people, the prospect of persistent higher-than-normal inflation has highlighted certain considerations:
- A fixed-rate mortgage is paid with money that will be worth less in the future, while rent is subject to annual inflationary adjustments. Additionally, real estate such as a primary residence can hold its value in an inflationary environment.
- Others are considering energy efficiency, which also has longer-term environmental benefits. For example, taking steps to improve the energy efficiency of a home, such as replacing old windows and doors, adding an extra layer of insulation in the attic, upgrading old kitchen appliances, and installing a programmable thermostat. Or considering a more fuel-efficient car.
While 2022 is off to a challenging start in the financial markets, history would suggest now is not the time for long-term investors to press the panic button. Quite the contrary, there are a number of proactive steps investors can take today that can help ensure they stay on track to meeting their long-term goals and objectives. The geopolitical unrest in Eastern Europe, rising interest rates and an inflationary environment, however, suggest that it may be prudent for investors to re-evaluate how their portfolios are presently constructed and consider adjusting their spending habits to help reduce the impact of rising prices.
1 “Global stocks suffer worst day since June 2020 amid slowdown fears.” FT.com, 9 May 2022.
2 “US inflation stays at 40-year high, defying expectations of bigger drop.” FT.com, 11 May 2022.
3 Source: Bloomberg. This shows the hypothetical return of a $10,000 investment in the S&P 500 Total Return Index from 1 January 1999, to 31 December 2021, not including taxes, fees or costs. It has been adjusted to show the impact on overall performance if that investment was taken out of the market after significant periods of volatility, thereby missing the subsequent market rebounds. Note: Hypothetical performance shown here is for illustrative purposes only and does not represent actual performance of any client account. No representation is made that hypothetical returns would be similar to actual performance. Past performance does not predict future returns.