Volatility, Market Timing, and Long-Term Investing
For many savers, the objective of a retirement account is to accumulate assets while you are working and use those assets to pay for your expenses during retirement. While you are in the accumulation phase, assets are usually invested and hopefully earn a sufficient rate of return to meet your retirement goal. For the majority, these accounts are long-term investments and there are certain investing ideas that should be taken into consideration when managing portfolios. This article will discuss volatility, market timing and their role in long-term retirement accounts.
“Market timing is the act of moving in and out of the market or switching between asset classes based on using predictive methods such as technical indicators or economic data” (Investopedia). In other words, trying to sell investments when they are near their highest and buy investments when they are near their lowest. It is difficult, some argue impossible, to time the market successfully enough to generate higher returns. Especially over longer periods. That being said, by reallocating portfolios and not experiencing the full loss during market downturns, investors could see higher returns. When managing portfolios over longer periods, this should be done without the emotion of day to day volatility but by analyzing greater economic trends.
So far, the stock market in 2018 has been volatile; particularly when compared to 2017. Below are charts of the S&P 500 from 1/1/2018 – 10/21/2018 and the same period for 2017.
Based on the two charts above, one could conclude the majority of investors would prefer 2017 100% of the time. In reality, the market averages a correction of over 10% each year and there are years the market goes up and there are years the market goes down. Currently, the volatility in the market has a lot of investors on edge, but when comparing 2018 to the market historically, one could argue this year is more typical than a year like 2017 where the market had very little to no volatility.
Another note from the charts above are the red and green bars on the bottom of each year. The red represent down days in the market and the green represent up days. You can see that even though there is more volatility in 2018 compared to 2017 when the market just kept climbing, both years have a mixture of down days and up days.
A lot of investors become emotional when the market is volatile but even in the midst of volatility and downturns, there are days the market is up. The chart below shows what happens to long-term portfolio performance if investors miss the best days in the market during that period.
Two main takeaways from the illustration above are; 1) missing the best days over a period in the market could have a significant impact on a portfolios performance, and 2) some of the best days in the market over the period analyzed came shortly after the worst days. This means that if people reacted on the worst days and took their money from the market then they likely missed some of the best days.
Market timing is difficult over long periods of time and making drastic moves in asset allocation because of emotional reactions to volatility isn’t always the best strategy for long-term investing. Investors should align their portfolios taking both risk tolerance and time horizon into consideration and make sure the portfolio is updated as each of these change multiple times over longer periods.
When risk tolerance or time horizon do not change, most investors should focus on macro-economic trends rather than daily/weekly/monthly volatility of the market. Not experiencing the full weight of stock market declines could generate higher returns and if data shows the economy may be slowing, it could be a good time to take some “chips off the table”. That being said, looking at past down markets, some of the best days occur shortly after the worst days and staying invested enough to keep in line with your risk tolerance and time horizon could be the best strategy.
It is difficult to take the emotion out of investing when the money is meant to fund your future needs so speaking with your financial consultant to review your situation may be beneficial.
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.