Strategic Insights | Behavioural nerve and long-term investing
“If you can keep your head when all about you are losing theirs” – Rudyard Kipling
Picture the scene. It’s 2005 and world champion poker player Phil Ivey arrives at the Rio All-Suite Hotel and Casino in Vegas, settling himself down to play a table at the World Series tournament. His face is inscrutable behind his dark glasses, his demeanour is modest and unassuming, and he is almost unrecognisable in his hoodie, pulled like a cocoon around his features. Headphones pipe music into his brain, drowning out all the commotion and adrenaline-infused hullabaloo around him. For the next few hours, for Phil Ivey, the world simply does not exist. All that matters are the cards arranged on the green baize before him, his long-term aim and his plan for achieving it. He realises that the next few hours will be somewhat bumpy and turbulent, but he understands his capacity for loss, and he is fully prepared to stay the course. By the time he stands up to leave the table, he will have won US$635,603.
If he were not already worth over US$100 million, Phil Ivey would make a very good investor.
Let’s zoom out and review the last twelve months. Covid-19 has been part of our lexicon and part of our lives since this time last year. And to say that global markets have been shaken by its impact is something of an understatement. But while turbulence on the stock market is often headline news and a source of extreme anxiety for investors, the bigger picture is always the one that we should be focusing on – as well as the long-term historical context. At Investment Quorum, effective, transparent communication underpins everything that we do. If we are not talking to you about the effects that world events can have on your investments, then we are not doing our job. So let’s historically contextualise the last year and look at what it may mean for the future.
When we first mentioned coronavirus in one of our Lowdown articles back in late January, it was anticipated that only the Asian markets would be seriously impacted. But within just a few weeks, it was clear that markets worldwide would find themselves buffeted as global economic activity started to be disrupted. Travel restrictions and lockdowns added to people’s fears and anxieties. And since financial markets dislike uncertainty more than anything else, twelve months on, global markets are still trying to price in the longer-term risks.
Volatility: the key takeaways
The end of February last year was a dire time for the S&P 500. The international press was full of words like “crash” and “meltdown” as market observers watched it lose 30% of its value. But the reality is that falls of this magnitude have happened throughout history and are simply a feature of the markets: 1987’s Black Monday, the Dot com crash and the great financial crisis of 2008, to name just a few recent ones.
But just as it is important to distinguish drama from mere intrigue, we should differentiate between market corrections, and market crashes… and significantly more serious events that attract labels such as “depression”, “meltdown” and “Armageddon” from the headline-hungry press. Corrections are 10 to 20% falls in the stock market. They happen every year or two, and the average fall is 13.7%. They last four months on average, and recoveries (back to pre-correction levels) have taken four months on average. Crashes are falls of more than 20% and happen once every four years on average. The average fall is 32.5% and lasts for 14.5 months on average, and recoveries have taken two years on average.
Since the Second World War, there have been 26 market corrections. But more significantly, the average return in the 12-month period following the losses incurred was more than 16%. Even more importantly, 80% of corrections over the past 75 years have not turned into crashes. And – as the archetypal blurb is so fond of reminding us – while past performance is not a reliable guide to future performance, so far, every single stock market crash has been followed by a recovery that more than made up for the fall.
By way of a parenthesis, comparisons between the current turmoil and the Great Depression of 1929 are not wholly justified. There are indeed problems ahead – such as a massive debt mountain to clear. But a century ago, we did not have the technology that we have today, there was a complete absence of central bank policy and there was all-round poor basic governance. In short, we can rest assured the economic cost of the pandemic is likely to be relatively short term.
What should I do?
Find and channel your inner Phil Ivey. The biggest temptation is to do something in a downturn, but the smartest decision you can make is to do nothing. Tune out the outside world, settle into your metaphorical hoodie and just continue doing what you are doing. In fact, if you invest regularly over time, you benefit from pound cost averaging. Regular investing month in, month out – no matter what the state of the market – will teach you to keep your behavioural nerve and adopt a non-emotional approach. You will buy high, low and everything in between… and you will capture the average return of the market.
“I know that riding the ups and downs of the markets can be uncomfortable”, says IQ’s Chief Investment Officer Peter Lowman, “but remember the investing principle of Warren Buffett: it’s time in the market, not timing the market that is the key to success”.
You have your long-term plan. You understand the difference between volatility and risk. You have your life insurance, you’ve drafted a will and because you know that life sometimes meanders or takes unexpected turns (divorce, bereavement, etc.), you check in with us from time to time and we review your plan together. Now all you have to do is tune out the short-term market fluctuations and the noise of the headlines as much as you can. Know your time horizon, focus on your long-term investing goals… and allow us to do the rest.
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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