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3 misconceptions about market volatility you need to be aware of

By Stuart Ritchie - June 01, 2022

As financial planners, it’s our responsibility to get our clients to stick to their financial plans for the long term.

This can include changing any preconceived notions that may exist.

This week I want to focus on market volatility.

Because many views and opinions that exist about it, are incorrect simply because of faulty thinking.

(For example, that volatility equates to risk or loss).

I'm reminded of the quote from American engineer, W. Edwards Deming. 

"Without data, you're just another person with an opinion".

Here are 3 common misconceptions about market volatility, and my take on them. 

#1: Market volatility is accurately represented in the media. 

Scary headlines increase readership and website traffic.

Headlines can be increasingly overwhelming or crucially – distracting.

Remember, the stock market has always risen despite annual ‘’Armageddon’’ events.

In reality, the media often doesn't represent the truth.

In fact, the stock market remains one of the most effective places to invest.

Focus on what you know and what you can control.

You know that you are saving for your retirement.

You know that if you save £5,000 per month you will reach your retirement income goal.

You know that the long-term average return on a balanced portfolio is between 5-6% irrespective of global, economical, and political shocks.

While news may feel consequential in the short term, it has little, if any, impact on the long term. 

There will always be another war, political unrest, or recession. The markets have always recovered and reached new highs.

#2: Cashing in during a downturn is the right thing to do.

In reality, it’s not.

It’s impossible to time the markets – but emotionally you may feel the urge to cash in when you see your investments dip.

You need to see the bigger picture.

Corrections will always happen.

Remember why you set up your investment account in the first place.

Has anything changed?

If not, there’s little reason to sell.

Your financial planner should account for growth as well as volatility at outset, and constantly ensure your portfolio is balanced for risk and aligned with your preferences.

All funds go through periods of poor performance and bounce back over the longer term.

Going back to the end of WW II, there has been an average market decline of 14 percent every year. Over the last 70 years, the markets endured:

    1. Assassinations
    2. Questionable political elections
    3. Nuclear threats
    4. Civil unrest
    5. War
    6. Oil embargos
    7. Five recessions
    8. Global terrorism
    9. Virus outbreaks
    10. Inflationary pressures

But the stock market has grown more than 150-fold.

If you had invested $500,000 in the S&P 500 index in 1950, it would have grown to $75,000,000, despite the endless market ‘’chaos’’.

These events are nothing more than a momentary distraction.

And if the whole market is underperforming, there’s little likelihood that moving into cash will help them recover any losses in the short term.

#3: It’s productive to keep checking the Dow’s performance daily. 

It's not. 

Some investors feel the need to obsessively check their investments several times a week or even daily.

This is counter-productive.

Stock prices go up and down on a regular basis – always focus on the long-term outcome.

Here’s a story I recently read, to explain why you should refrain from obsessively checking your portfolio value.

After investing $1,000 dollars in the stock market, a couple set off on a world cruise.

There was no internet access and no way to find out how their investment was doing. When they returned from holiday, they didn’t know that at some point their investment lost all its value – because it had recovered all its value and more the day before they arrived back.

That couple had no need to worry about their portfolio and investment value – and the same goes for you as investors. The market has always returned stronger than ever.

Your planner is there to do the day-to-day worrying about your investments.

Focus on the outcome.

One more bonus misconception.

Last, but by no means least, is the misconception that when shares fall in price, they lose value.

In reality, they don’t.

Many investors feel that when an investment goes down, the price has dropped and so has its value.

This isn’t the case.

We all love a bargain, we snap up things when they go on sale because we see them as a good deal. When an item is marked down we don’t assume it's damaged or of a lesser value.

But many see investments differently, feeling that when investments go down in price they’ve lost out.

During periods of volatility, view your investments like a marked down commodity.

The lower price shouldn’t skew your perception of the ‘real’ value of the investment.

Finally, here are some other nuggets on volatility which should hit home:

  • Volatility does not equal risk – the only risk is how you react to volatility
  • Volatility's bark is worse than its bite – when markets are doing well our brains release dopamine. In a slump the brain signals danger, which triggers our fight or flight mode
  • Volatility does not equal loss – if you abandon your strategy mid-slump, then volatility equals loss.

Calm, patient investors triumph.

We can’t time the market and it always runs in cycles.

Timing the market is never as consistently successful as staying fully invested.

Rationality beats emotion.

Investing is simple, but not easy.

Which is why we coach our clients along this investment journey.

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