Financial markets can be quite turbulent at times. Consistently predicting short term market movements is almost impossible, even for the experts.
As the old saying goes, time in the market rather than timing the market is the key to investment success.
Many investors have a tendency to sell when the market declines out of fear it will continue to fall and never return. This is normal human behaviour as people don’t like uncertainty and will try and avoid risk of losses if possible. Studies have shown that people feel the pain of losses 3x more than the enjoyment of profits.
Short-term market movements and losses are usually followed by longer periods of recovery, and investors who are invested for the long-term end-up reaping the rewards. Since the depths of the financial crisis in 2009, the US stock market has risen over 200% and the Australian market over 100% including dividends.
Improving your odds
The longer you invest, the better your chances of making a profit.
You can think about investing over the short term as being like a casino, or flipping a coin, since on any day there’s about a 50% chance of the market going up and a 50% chance of the market going down. Trading day-to-day is difficult even for experts because brokerage and other trading costs are usually larger than any winning streak. As a result, most ‘day-traders’ lose out as trading costs add up the more they buy and sell.
As you invest longer, the probability of making a loss declines and the odds of being ahead shift in your favour. Over the long term you become the casino owner and those trading short-term end up paying you to play.
Investing will always be riskier for short-term investors than for those who are in for the longer-term. This is why we recommend all clients have at least a 3 to 7 year investment time frame to improve their opportunity for success.
The long-term trend
Over the past 20 years, financial markets have trended up despite some corrections along the way. Unlike individual shares, broad markets don’t go ‘bankrupt’ or disappear. Some companies within the broad markets might disappear but they are replaced with more successful businesses so those who own broad markets benefit from this continuous renewal process.
All of the 5 asset classes currently in the Stockspot portfolios have enjoyed gains over the long-term – despite some bumps along the way.
However, the performance chart looks rather different when we zoom into a much shorter term period of a year. The movements of each asset class during 2014 were much more unpredictable with brief periods of gains and losses – despite gaining overall.
This is why we believe that time in the market and owning the right investment mix across different assets and regions is the best strategy for reducing risk and optimising returns. For example, the investment mix within our Sapphire (moderately conservative) portfolio has had 18 positive years and only 2 negative years since 1995.
What you can do when markets fall
Here are a few ways investors are can take advantage of market dips.
Stick with the long-term plan. Market dips can be a good time to top-up your investments since you’re able to benefit from buying stocks at a cheaper price. Setting a regular investment plan will also help manage the risk of market movements and help balance out how much you pay for your investments. This is one reason we don’t charge extra for brokerage, so that clients can invest as often as they like.
Take a break from monitoring
If you have a tendency to get nervous when your investments go up and down, consider monitoring your portfolios less frequently. This helps prevent your short-term emotions from overpowering the long-term game plan.
Don’t forget dividends
Even though the value of companies might decline over the short-term, it’s likely that you’re still earning returns through dividends and distributions. When markets fall, dividends and distributions can be reinvested at a lower price, helping you benefit even more when markets do recover.
When investing in broad markets, sticking to your long-term investment plan is vital to ensure you have the best shot at success. Taking small actions to stay focused on the end-game will help you avoid the traps many investors fall into when markets are bumpy.
Low fee, hassle-free investing
Stockspot is Australia’s fastest growing automated investment service. We can help you build and manage a personalised portfolio tailored to your financial situation and your goals. With Stockspot, there’s no paperwork, no need to be an expert and no hassles.
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Past performance of financial products is no assurance of future performance. Actual performance of your portfolio may vary from our published returns due to the timing of investments, rebalancing and your fee tier. The Stockspot indices have been published since July 2013 and open for investment since May 2014.