Market Response to Crisis
I am sure you have noticed; the market is down. People are nervous or fearful and those feelings are not unwarranted. Even though we have lived through the Avian Flu - H5N1 and the Swine Flu – H1N1 outbreaks, this feels a little different. I obviously can’t tell you when we will get a vaccine or when the market will make a comeback. However, I can tell you what the market’s response to previous crisis has been and what we can learn from it.
Let’s take a look at a globally diversified portfolio consisting of 60% stocks and 40% bonds. What happens in the years following a crash in the market?
While a globally diversified portfolio would have suffered losses immediately following these events, over time the markets recovered as you can see in the 5-year cumulative total returns. Emotions may get in the way during these events and tempt investors to sell. But diversification and a long-term approach can help investors stay disciplined to ride out the storm.
Unfortunately, many investors follow their emotions when making decisions in their portfolio. When we don’t separate our emotions from investment decisions poor decisions can be made at the worst times. We ride a wave of optimism in the market on the way up buying while the market is high, then react to nervousness and fear by selling as the market declines.
What investors typically want to do is wait for the market to “settle” or let things “calm down” before they get back into the market. The problem is that by waiting for volatility to settle, you may miss out on potential gains. Missing a good day in the market can have a significant impact on returns.
Right now, and in the upcoming weeks you can expect more volatility than you are used to seeing. You can also expect there to be more noise in the media about the market decline not being finished and that it will only get worse. My advice is to stick with a long-term approach, remain diversified, rebalance when possible, and wash your hands.
-Some of the material above was provided by Dimensional Fund Advisors LP.-