It’s time to practice the skills of a disciplined investor

When markets are volatile it is normal to feel anxious, which is why adhering to core financial planning principles are so important. When markets are rallying and going up steadily, there are less concerns for many investors. As we have been saying to our clients across all parts of the economic cycle, markets do not move in straight lines. When markets are growing and returns are larger than normal, that is great, but do not expect that to be the norm every year.

When markets are volatile or when they are falling, following core financial planning principles can help you to stay on track and the discipline of doing so can have profound effects on your returns over the long term.

If you are concerned about current affairs and the fluctuations in your investment performance from one day to the next, we recommend you go back to these core principles.

Volatility and risk

Knowing the difference between volatility and risk can give you the peace of mind you need to stay on track with your financial plan.

Volatility is how much prices move- up or down- from one day to the next. A degree of volatility is ‘normal’ or acceptable. When volatility is higher, the question to ask yourself is whether your investment remains aligned to your long term goals.

Risk is different. Risk is the chance of absolute loss.  This is different from volatility. Volatility means your investment may be worth more or less than yesterday, but that the fundamentals that underpin the investment remain unchanged. Risk means your investment could reduce to zero and not be worth anything in the future. It is important to understand the difference between the two.

Here is an example: you invest in a global ETF that holds assets in the world’s largest 500 companies. In a period of market uncertainty the value falls 15%. This is volatility. If the companies in which the ETF is invested remain sound with strong balance sheets, their share prices, and therefore the value of the ETF will rebound over time. If however, you invested in one speculative small company stock, that company could go out of business and be forced into liquidation. In this case, the shares fall in value to zero and you lose all your money- this is risk. A diversified portfolio reduces this risk.

Goal focused

The next principle is to remain goal focused. If you are running a marathon at the Olympics it is not so important what your 100m sprint time is. It is the same for investing. If your timeframe is 10 years, for example, it doesn’t matter what happens within one month. This comes with the caveat that core investment fundamentals remain sound and acknowledges tactical adjustments across market cycles.

More importantly, it reinforces that one should not react against moves that have already happened, that one should not be reactive to the current days news, and one should also not try and time the market. As has been stated many times, there have been many investors that have lost a lot more money trying to time a market, than those that have sat through a market downturn (and recovery).

The key assessment we conduct for our clients is whether you are on track on average across the economic cycle realise your goals. Not what is happening in the world today.

This leads us to the next principle.  

Time and volatility

The one key factor that reduces volatility and periods of negative returns is time. Time reduces volatility and the likelihood of a negative return. If your timeframe is long term, focus on the long term.

The graph below shows that in any one year period there is the potential range of returns from a balanced portfolio from between +40% to -24%. This is based on actual market data over the last 75 years. You have about aa one in six chance of a negative return in a one year period. Over time that downside risk falls markedly. The graph below shows there is almost no chance of a negative return over a five year period in a balanced portfolio and the statistics present there has been no ten year period that generated negative returns across the range of this study.