A few months ago, I was in Vancouver having coffee with a colleague, Jayelene Catala. She reminded me of the visual below (yes, that is my handwriting!) which I have used in past presentations. It is a subset of a list that I came across while preparing a presentation in early 2019, not long after the significant market volatility that we experienced at the end of 2018.
At that time, I thought these points were great for all investors to keep in mind. They are no less relevant today given continued volatility. The list is a good reminder of some of the key principles that I have written about in previous posts: the power of diversification; try your best to ignore the noise; and stick to your long-term investment plan.
I am often asked which one is my favourite. I don’t actually have a favourite – to me they are all equally important. I think it is worth exploring each one, but taken together these points are a great foundation for any long-term financial plan.
Your asset allocation explains most of your returns
Your asset allocation specifies the proportion of your portfolio invested in various asset classes like stocks, bonds or alternatives. It helps to balance the risk and return in your portfolio, anchoring it through different business and investment cycles, and is a key driver of your long-term investment performance. Asset allocation is often the single most important decision you will make as an investor. You need to get this part right.
Diversification is your most important investment strategy
Different asset classes go up and down at different times, so taking a diversified approach to your investments can help a lot during periods of volatility. A well-diversified portfolio should lead to smoother, more consistent returns. This will likely help you stay invested over the long-term versus selling your investments in volatile times.
Broaden your investment universe to find opportunities
As investors, you want to take advantage of all of the opportunities that are available to you. The more options that you look at, the greater your ability to diversify. By taking a global approach and looking at investments outside of the concentrated Canadian market, you tap into the other 97% of the world’s available investment opportunities. This improves diversification, which should ultimately lead to a smoother investment experience (see my previous point).
Market uncertainty never goes away
The one thing we know for sure is that the future is uncertain. This uncertainty often scares investors away from markets or into trying to time them. The key to investment success is not to try and predict the future. Rather, it’s about building well-diversified and resilient portfolios that can weather the storm no matter what market environment we are in.
Higher returns come with higher risks
Risk is fundamental to investing. No discussion of investment returns or performance is meaningful without also considering the level of risk involved. If you want the potential to earn a higher return on your investments, then you have to be willing to accept more risk or volatility (think swings in the value of your investments). But investing success isn’t always about chasing higher returns by maximizing risk – it’s about finding the right balance between risk and return that works for you. If your tolerance for risk is low, then you’ll have to give up some return in order to achieve that. As the old saying goes, you can’t have your cake and eat it too.
It’s time in the market, not timing the market
In a previous article, I mentioned that it’s time in the market, not timing the market that leads to investment success. Investors trying to time the market need to make two correct decisions – when to get out, and when to get back in. Even if you manage to find the right time to get out of the market, it’s highly unlikely that you will get back in at the right time. This will have an impact on your results. Take 2019 as an example. If you became nervous during the volatile period at the end of the 2018 and moved to cash, then you missed out on some impressive returns during 2019. Sitting on the sidelines and missing some of the strongest days in the market can have an impact on your investment returns.
The cost of missing the best day in markets
Note: As of December 31, 2020. Returns represented by the S&P/TSX Composite Index. An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Source: Morningstar Direct
Markets are made of up and down cycles
We are now in the longest business cycle and equity bull market in history. This has allowed many investors to earn higher than normal investment returns. The length of this up cycle may have caused some investors to forget that the market moves in up and down cycles, so markets will correct eventually. This is a normal part of markets. It should not cause you to divert from your long-term investment plan.
No strategy outperforms all of the time
Markets are unpredictable. No single asset class consistently outperforms, so it is not realistic to expect your investments to outperform all of the time. On a day-to-day basis, it boils down to a coin flip as to whether financial markets will be positive or negative. But as you look at longer time periods, the likelihood of a positive return increases, provided that you are in a well-diversified portfolio. Time is your biggest asset.
Historical odds of each holding period being positive
RBC Select Balanced Portfolio
Note: Series A performance from January 1, 2000 to July 31, 2021. Click here for more information. Source: RBC GAM
You need to keep your emotions in check
Being aware of how your emotions can impact your decisions and tempering your reactions during volatile markets can help you to avoid poorly timed changes to your investments. This is easier said than done, even for professional investors. That is because the bad feeling that you get from losing money on your investments far outweighs the good feeling that you get from gains. Keeping your emotions in check is easier if you have a financial plan in place. Stick to your long-term investment plan, especially during periods of volatility.
A down market does not equal a personal financial crisis
My last point is actually a good summary of all that I have talked about so far. Keeping the previous nine points in mind will provide a solid foundation for navigating volatile markets and the effect they have on your portfolio. If you invest in a well-diversified portfolio and stick to your long-term financial plan, a down market does not equal a personal financial crisis (something I have to remind my family of quite often). In fact, you may shift your thinking and begin to view a market sell-off as an opportunity to buy something on sale!