Market correction reaction will differ from investor to investor, often influenced by their history as investors. As an investor (opposed to operating as a trader), time is your friend – and patience in following the core of your strategic financial plan – should see most of you emerge from such situations in due time.

In a recent article published1 to financial planners across the globe, the independent ‘risk appraisers’ FinaMetrica provided guidelines for consideration by investors in coping with recent volatile markets. This group uses psychometric tools to help assess the investment risk profile held by individual investors – they have a sound understanding of the emotions that come into play with investors.

As part of our continuing efforts to keep clients informed about all aspects of investing, the extracts below reflect familiar messages that we have published over the past few years.

The following points (together with some supporting graphs) have been extracted for your consideration. (Omissions from the full article are either of ‘re-stated’ data, or of industry-related comment.):

“The recent falls in equity are not the worst in recent memory and it is inadvisable to make snap decisions on investments.

While it is reasonable for investors to be disappointed with the state of the markets, even the state of their portfolio, (but) they should not be surprised. History shows that this correction is not the worst on record.

In the lifetime of a portfolio there will be infinitely more bad news stories for investors who look at their investments in a disaggregated manner compared to the ones who simply look at the overall balance.

Attempting to time the market and panicked investment decisions are perhaps the two greatest enemies of investors’ wealth. The latest market volatility research by FinaMetrica looked at the four greatest All Ords falls of the past 40 years and examined how diversified, rebalancing portfolios behaved compared to just the performance of the All Ords.

Five History Lessons

  • The call by investment pundits that ‘this time is different’ has rarely been correct. Markets have invariably recovered.
  • Instinctive market reactions tend to destroy investment value. There is ample evidence that investors … generally enter and leave (the markets) at the wrong times. They often sell on reports of large declines and tend to buy when everyone else has made money.
  • … Being always out of the market and invested in bank deposits keeps investors just ahead of inflation. Sometimes the outcome can be much worse depending on timing and taxes.
  • Holding an ‘all equities’ portfolio is rather like riding on the back of a bucking bronco. …
  • Investing with discipline has worked. The table shows three portfolios taken from the FinaMetrica Risk and Return Guide AUS compared to three benchmarks – inflation, bank deposits and an all equities portfolio. Diversified asset allocations with 30%, 50% and 70% growth assets, rebalancing once a year, have delivered reasonable returns. This has been better than inflation and term deposits. …

Average Annual Rolling 10 Year Return Returns

Inflation Term Deposit 30% Equities 50% Equities 70% Equities 100% Equities
5.5% 8.6% 11.6% 12.3% 13.0% 13.7%
(Rebalancing once per annum since 1972)

These are of course average returns. Markets do not run this smoothly. What is infinitely more challenging for investors is coping with extreme events associated with investment markets. …

….

The graphs below show both the drop and recovery period of portfolios with 30%, 50% and 70% equities against the All Ords TRI in recent market falls.

….

There is nothing about current events that necessarily changes future expectations. Nevertheless:

  • It may be a good time to review … financial plans, particularly … goals and aspirations compared to likely available resources.
  • It may be a good time to rebalance … portfolio(s) and look to acquiring underpriced assets.
  • It is worth remembering that market declines often generate tax management and estate planning opportunities.
  • Finally … now might be a good time to re-examine (agreements as to what to do in extreme market volatility; and asset allocation generally).

Whatever you do, it is not a good time to make snap decisions. … it can take a fairly long time for the market to reach the bottom and recover, importantly it has done so every time.”

1 These extracts are from the article published in the FT Adviser under the Title ‘Rollercoaster Ride’, on September 8th 2011. Its author was Paul Resnik, co-founder and director of FinaMetrica.