Lessons On Volatility and Your Financial Plan

by Nick Stewart (Financial Adviser, CEO)

It can be tough not to panic and succumb to a knee-jerk response when markets are experiencing a substantial drawdown like we have seen this year. Stress levels are naturally high and the temptation to “do something” can feel over-powering.

But history suggests that those investors who keep their nerve, stick to their agreed financial plan, and maintain focus on their chosen horizon at these times tend to do significantly better than those who sell assets that have already fallen in price.

We only need to go back to the events of 2020 to see the value of staying the course. The headlines in March of that year spoke of catastrophic outcomes. The pandemic, combined with an oil price war and recession fears, drove $9 trillion from global equities in days.

We now know (with the benefit of hindsight) that the economy actually performed relatively well through the pandemic. Global equities bounced later in the year as vaccines emerged so that by November major benchmarks were back at record highs.

Of course, this time is different. The circumstances are always different. The pandemic disrupted global supply chains just as massive fiscal and monetary stimulus was firing up demand. The war in Ukraine added another dimension, with prices of oil, food, gas and other commodities soaring. Inflation in many developed economies has reached levels not seen in decades. And central banks, after confidently predicting a year ago that inflation would be transitory, are now aggressively lifting benchmark interest rates.

But it’s not all bad. Over in the US, the Dow Jones Industrial Average locked in its best month since 1976. That’s the best month it’s had in my lifetime, rising 14% while the S&P 500 and Nasdaq rose 8% and 3.9% respectively.[i] That’s just one aspect of the whole picture, so take the news with a grain of salt – but note how that hasn’t appeared anywhere in NZ media, which is all fairly doom and gloom regarding the economy at the present.

Here are some lessons to keep in mind:

1.       While you may be tempted to take refuge in cash “until the storm passes”, market timing is difficult to pull off. You risk turning paper losses into real ones and missing the bounce when it comes.

2.       Balanced portfolios have quickly regained losses after past significant declines in the past.

3.       The recent past doesn’t tell us anything about future returns. Prices of shares and bonds have adjusted lower in recent months. That means that all else equal, expected returns are higher than they were late last year. If the news going forward – on issues like inflation, economic growth and earnings – is better than what is currently reflected in prices, asset prices could adjust higher. In this context, remember that what moves markets the most is news it didn’t expect.

4.       While market timing can be counter-productive, you can still use the opportunity of lower prices for stocks and bonds to rebalance your portfolio back to your chosen allocation. This, however, is part of a disciplined, regular, and structured process, not a knee-jerk response to volatility.

5.       Recessions are always identified with a lag. And even if there is one, the record shows that markets are often on their way to a recovery by the time the recession is confirmed. That’s another argument for staying disciplined.

6.       In any case, even in tough economic environments innovation and wealth creation continue. Companies still bring together raw materials, technology, labour, intellectual and financial capital to develop new products and services that create wealth for shareholders. Governments and companies still need to raise funding in bond markets to deliver services and build long-term infrastructure. Investors who participate in bond and equity markets have an opportunity to share in the wealth created while financing those developments.

7.       Finally, a well-constructed financial plan will make allowances for periods like the present. The right plan will help you see past the daily news headlines so you can stick it out to get to the good times on the other side. Uncertainty is a constant. But if there were no uncertainty, there would be no return. And while the good times don’t last forever, neither do the bad.

There is no downplaying the emotional effect of times like this when even the fixed interest part of your portfolio is showing negative returns. But these times, while unwelcome, are not unprecedented or unexpected.

As ever, diversification, discipline and sticking to your agreed plan, with regular balancing, is still the best course to navigate this or any storm. And if you have any concerns about your plan – seek advice from a trusted financial adviser before taking action.

• Nick Stewart (Ngāi Tahu, Ngāti Huirapa, Ngāti Māmoe, Ngāti Waitaha) is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.

• This article was created with support from Dimensional Fund Advisors. The information provided, or any opinions expressed in this show, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz

[i] https://theweek.com/stock-market/1017967/the-dow-just-had-its-best-month-since-1976