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Investors have had to deal with multiple shocks to the financial system over the past few years. The outbreak of the Covid pandemic, the associated supply-side shocks and inflationary pressures, Russia’s invasion of Ukraine, higher interest rates and most recently, a high-profile bank failure in the US. Previous feelings of euphoria when markets were rising may well have turned to fear and desperation, with some investors considering heading for the exits. But should they?
Volatility in global markets is normal, and it’s important to keep in mind long term investment plans rather than changing strategy based on inevitable short-term fluctuations. Instead of panicking and seeing a downturn in the markets as a time to sell, investors should consider some of these as attractive buying opportunities. The illustration below shows how investor emotions can alter during different points of the financial risk cycle and how this may present opportunities as markets recover.
Benjamin Graham
Source: Capital Group 2022: ‘Don’t panic. managing market driven emotions .’
‘Anchoring’ happens when investors rely on a specific number, such as the value of their investments, or the level of the stock market, as a catalyst for making investment decisions. This can result in them becoming unduly pessimistic about prospects for their portfolios. Markets may have shifted, up, down or even sideways, and this can lead them to make hasty decisions that may not be in their best long term interests.
It’s important to keep in mind long term goals and try to avoid making decisions based on short term trends or following the crowd. Remember that recent market sell-offs need to be put into perspective. Over time they have risen steadily. Since 1950 for example, the S&P 500 has generated an inflation adjusted return of 7.5% per year.
Research shows that humans tend to feel losses much more acutely than gains. Often, this can result in behaviour known as ‘loss aversion’. Sometimes this means investors make decisions that aren’t in their best interest. For example, by reacting to a downturn by shifting their holdings into more low-risk investments. These may temporarily stem losses but severely affect the chances of reaching their long term investment objectives.
Investors should remember that periods of ups and downs are part of the normal market cycle. These ‘losses’ they see during a down period are only realised if they sell their investments. Although it can be difficult, investors should try not to be afraid but should keep in mind their long term investment goals.
From the importance of diversifying your portfolio to a five-point investment checklist, this guide highlights what to consider when investing in periods of market volatility.
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