Rational Investing Through A Down Market

Rational Investing Through A Down Market

Investment markets have been providing investors a rough ride in 2022. While falling markets can be worrisome, a rational reminder to understand markets and risk may help keep things in perspective.

Emotions & Averages

A typical first response to unsettling markets is an emotional one. Taking control and selling assets that have caused you pain may feel good while waiting for more “certainty” before re-entering. But if the basic principle of investing is to buy low and sell high, why not realize that prices are now lower and buying presents better forward-looking opportunities?

Think of it this way: if you have a discount from your favorite salon or restaurant, does the deal make you more or less likely to buy? Of course, you’d prefer to save money and get a better value. Then why not the same for your investments?

You have undoubtedly heard that risk and return are related. You can expect more return from owning companies (stocks) than lending to companies (bonds) or holding cash over time. However, those returns are rarely delivered in a smooth pattern. There are periods when markets fall precipitously and others when they rise inexorably. The only way of getting that “average” return is to stay invested and go with the flow.

Think about it this way: a sign at a river’s edge reads, “Average depth three feet.” Reading the sign, you think: “OK, I can wade across.” Yet, you surprisingly discover the “average” masks a range of everything from a few inches to 15 feet as you get carried downstream.

Historical market returns are often thought of as offering “average” returns of about 10%. Yet, individual year returns can be multiples of that average in either direction. Understanding possible outcomes from your investment choices helps set proper expectations while avoiding emotional responses that may cause harm.

For example, take the S&P 500 index. From 1970 through 2021, the lowest 12-month return was -43.3% and the highest 61.0%, starting in July 1982 and March 2008, respectively. The average annualized return over the entire period was 12.5%. You had to remain fully invested to earn that 12.5% return, taking the unsettling down times and not panicking out.

Timing investment markets is a challenging task. History shows that the worst investment days are often followed by the best days. By the time you feel better and more certain to reinvest, you will likely have missed much of the rebound in price.

What To Do

Markets are comprised of nearly 8 billion people on earth. Every day people make decisions and take actions that impact markets. Markets assimilate information into prices — a share of stock, a bond, or a home for sale in your neighborhood. Bad news and negative sentiment is already priced in.

What happens next – the future – no one knows. Are we in for more pain or more gain? Short of a crystal ball, best to diversify and spread your risk.

For instance, in 2022, while stocks and bonds have been performing poorly, floating-rate bonds, commodities, and trend-following strategies have been doing relatively well. Many have found they were undiversified and swimming naked as the investment tides rolled out in 2022. If almost everything in your portfolio is down, probably time for a second opinion.

The good news is the recent price declines may be an opportunity to make lemonade from lemons. It’s time to harvest tax losses, execute Roth conversions, and rebalance – selling what has done well and buying what has done poorly. Ensure your investment strategy is prudent, diversified, and well-aligned to your financial life plan. If you’re not equipped to handle this on your own, or you want to delegate to an expert and focus your valuable time elsewhere, perhaps it’s time to find a trustworthy and competent advisor with experience and success in helping people like you.