Markets may fluctuate, but solid investment principles abide
The Russian invasion of Ukraine has had predictable effects on financial and commodity markets. In addition to increasing market volatility, the big U.S. stock indexes are well down from their 52 week highs, and are deep into correction territory. The S&P 500 Composite Index is down over 10%, while the Nasdaq Composite Index is down 18% and approaching what is generally considered to be a bear market (down 20% from a high).
Yet Toronto’s benchmark S&P/TSX Composite Index, while suffering increased volatility, has barely declined at all in percentage terms from its 52-week high. Crude oil recently traded at US$123 per barrel, up 89% from a year ago. Gold briefly crossed the US$2,000 per ounce mark, and is up 16% from a year ago.
What is the average small investor to make of all this? Do you sell stocks? Buy energy stocks in Canada? Buy gold? Sell everything and put your money under a mattress? Actually, none of the above.
The Ukraine war certainly has had an impact on commodity prices, particularly energy, given that NATO alliance members and many other aligned countries have placed embargoes on Russian crude oil. That has had an immediate impact on near-term supply, driving crude oil prices to recent highs, at least temporarily. That’s given a quick lift to the energy sector, and by extension helped support the S&P/TSX Composite, owing to the heavy weighting of energy (and resource stocks in general) in the index.
But it hasn’t much helped the big U.S. indexes, which are impacted more by the industrial, technology, consumer, and financial sectors. The growth-driven segments of the market, such as information technology, were already undergoing revaluation in the wake of the pandemic, as the market was seeing a rotation away from growth into value. The Ukraine war exacerbated this trend, bringing on a correction in the big U.S. indexes much faster than had been anticipated.
For retail investors, this has presented some worrying moments.
However, such periods of volatility are never a good time for wholesale portfolio resets. The daily diet of rumor, hyperbole, and misinformation dished out by the daily media (social and legacy) feed can raise the level of investor anxiety to the irrational. And basing portfolio decisions on the irrational is never a good idea.
Here are some tips on how to avoid being whipsawed by the market:
* Don’t sell on emotion. No question, the market is an emotional place. And it can be easy to succumb to intense feelings of fear. But resist the urge.
Before you sell an asset, ask yourself why. Has anything about the asset that’s changed? Have company’s revenue, cash flow, earnings deteriorated so badly from last week when you thought your investment was brilliant? Has the stock price reached your pre-determined sell target level? If you have no good reason other than “the market is falling,” you’d better re-check your risk tolerance and your ability to withstand market volatility.
* Avoid market timing. Most retail investors who attempt to time the market by selling at the top and buying in at the bottom in fact do the opposite. They’ll generally miss make trades after the big moves have already happened and thus miss both the top and the bottom of a trend or a cycle. And all the while, they’ll incur trading commissions, ending up no further ahead than if they had stuck with a disciplined price-target strategy.
* Don’t follow the herd. Many novice investors jump on the sell bandwagon simply because “the market is tanking.” After all, millions of investors can’t be wrong, can they? In fact, they can be wrong, and frequently are. If you sell only because the market is declining, you’re just following a herd mentality, usually right into a hole.
To avoid these traps, I recommend three proven money management principles.
1. Discipline. Make an asset allocation plan for your portfolio based on your risk tolerance profile and stick to to it. This is critically important. If you succumb to the “fear” part of the fear/greed equation each time the market indexes take a dive, you’ve made a fatal mistake in your financial planning. If your asset allocation was good before the selloff, and your security selections made sense then, what’s changed? The discipline lies in making sure you don’t blow up your portfolio at every turn – because you’ll almost certainly do it at the wrong time.
2. Patience. The longer you stick with your plan, the more likely you are to achieve your wealth creation targets, regardless of market fluctuations. Stocks outperform virtually every other asset class over the long term.
3. Prudence. Selecting individual assets that meet your investment and risk-tolerance criteria for a portfolio can also be a challenge. Screening, researching, and selecting investments is time consuming and can be complicated, given the sheer volume of information available. If you’re not keen on that sort of financial analysis, work with your financial advisor to select professional investment management. This can include anything from discretionary portfolio management to pooled funds, to investment funds, depending on the size of your portfolio.