3 important tables for financial management across investment cycles
This article about market cycles. We are in a volatile market this year and in times like this that it is both most important to be focused on the long term, and most difficult to not be impacted by short term market movements.
As we analyse markets, read and review commentaries and the different and sometimes contradictory positions of market pundits and economists, we reach two conclusions:
No one knows precisely what will happen in the markets tomorrow. We can determine, from analysis and experience, the changes in market cycles and where we are heading in the next phase of the market, we know how to position for these changes, and how to manage assets over the long term. In that sense, day to day movements become less important.
Despite the conflicting positions of market experts, whether they believe we are at a market bottom, half way through, or in recession or not, whether their outlook is negative or positive, they all tend to agree with each other, and us, on the best course of action to manage your investments. That is, to focus on the long term, and not make reactive and short-term speculative changes.
There is some valuable data that backs up this assertion that the best course of action is to focus on the long term. The 3 tables below taken from the latest JP Morgan Guide to the Markets illustrate the benefits of this approach.
Table 1 Top performers
First, the table below shows the best performing asset class of each year since 2007. It also shows the consistent returns of a diversified portfolio. This table reinforces that if you maintain your position in a well-constructed and managed diversified portfolio you will attain better aggregate performance over the longer term with lower volatility. To do this, you need to avoid reacting to market movement and trying to guess the next big thing. There are many examples below where one year’s top performer became the next year’s laggard.
Table 2 Risk reduces over time
This second table helps to put short term volatility in perspective. It shows the rolling returns over 1 year, and 5, 10 and 20 years. What is evident is that the risk of a negative return reduces markedly over time, and for a diversified portfolio is positive for all timeframes, 5 years and longer. Risk reduces over time.
Table 3 The importance of good advice
This third table is the most important of the three. It clearly highlights the benefits of diversification with diversification greatly protecting in more negatively volatile markets. It also shows the dangers of trying to time markets and reacting against short term volatility. This is real data presented by JP Morgan and it shows that whilst the average balanced portfolio has returned a compound annual return of 7.4% per annum over 20 years, the average self-managed investor has realised only 3.6%. Therein lies the danger of reactivity. Investor behaviour, distracted by short term market movements can lead to lower performance in the long term.
What about opportunities?
Volatile markets can be a good opportunity for investors entering the market.
For investors already in the market, rebalancing and ensuring your portfolio is aligned to your goals is important, and if you have the ability to add to your investment, you have the same opportunities as new investors.
Summary
Market volatility can be stressful and make us feel like we need to react. The evidence suggests though that staying diversified, being focused on your long term goals and not reacting to the market movements will likely lead to a much stronger result and help you to achieve your goals.
