We have mentioned many times over the years how investors who are able to manage stock market volatility will have greater success then those who do not. We are strong believers that being able to deal with volatility can be learned, as opposed to being genetically ingrained in our DNA.
In fact, every investment experience we have helps develop how we feel about investing today — whether those be good experiences or bad experiences. One of the questions we cover in a first meeting with new clients is to obtain an understanding of their past investment experience.
Emotional cycles of investing
Nearly two decades ago we would provide new clients with a chart that would show the typical emotions in the investment cycle. Below is the fear, hope, and greed market cycle chart:
Fear, Hope, and Greed Market Cycle
Prior to investing with new clients we would ask where on this chart they feel we are currently at in the market cycle. We would also ask when they think the best time to invest is.
One benefit of the above chart is that it highlights that the thrill or euphoria stage often precedes the period of greatest risk (in the short term). On the flip side, if people are capitulating and feeling despondent, we may be reaching the period of greatest opportunity (in both the short term and long term).
Impossible to time the market (in the short term)
The next part of the discussion would highlight that timing the stock market is nearly impossible. Bull market cycles last far longer than most people can imagine. Pullbacks can happen suddenly when you least expect it.
Simply put, stock markets can be completely irrational in the short term. Anyone who has invested for any length of time knows this. Economic data could be pointing in one direction with the markets reacting in an opposite way.
At times, investors’ emotions of fear, hope and greed dictate more of what they do versus what they should do. We will call this the short-term “psychology factor.” It is the psychology factor that makes managing investments a continual challenge. In the long term, markets provide solid returns for disciplined investors.
How we react to uncertainty
The key with The Greenard Group model portfolios and investment approach is to always have the best quality investments and avoid all forms of speculation.
Quality investments will always ride through the bumps in different market cycles. In our opinion, it is the speculative names and bad periods in the investment cycle, that have provided investors with bad experiences.
Investors panicking and selling at the wrong time is also a factor that is harmful for many investors. Explaining to clients before they begin investing that they will have these feelings may help with emotional coregulation.
Determining the correct risk tolerance and asset mix (percentage invested in cash, fixed income, and equities) is critical. A Portfolio Manager must feel confident that if the markets decline in value that the client will stay the course and understand that it is part of the investment cycle.
One of our favourite sayings is: “We can’t control the direction of the markets, but we can control how we react to it.”
Index charts provide better picture
The fear, hope, greed market cycle chart always gives the appearance that the markets have a net zero gain situation over time. Outside of the emotions investors may feel, the chart gives the impression that the only way to make money is to sell near the euphoria stage and buy near the despondency stage. As noted above, it is impossible to time the markets.
Over time, the markets have always had periods of volatility, but have maintained a strong upward bias over the longer term. Regardless of the short-term “prediction,” we are more confident in the longer term that both the S&P500 and S&P/TSX Composite Index (the “indexes”) will be higher in the future rather than lower. Taking a longer-term view of your investments should help reduce the stress of attempting to predict short term performance.
In addition to reviewing the Fear, Hope, and Greed Market Cycle, investors should review the cumulative returns of the indexes. Financial institutions often have “Andex Charts” hanging on the walls, which provide so much great information. The key takeaway when looking at the indexes or Andex Charts is the benefits of staying invested over time.
Reactions to market volatility
We feel it is very important for Portfolio Managers to discuss market volatility thoroughly with all new clients prior to doing any investing. An example of a question we have asked is: “How would you react to certain market conditions (overall market declines of 10, 20 or 30 per cent)?”
We also review past periods in the markets when declines have occurred and the amount of time required to fully recover and reach new highs. By going through these discussions we hope that new investors will establish a disciplined approach and that the investment asset mix will reflect their risk tolerance.
Here is an example of one of the questions we ask:
Assume you have just invested $1 million and intend to leave the money where it is for a minimum of 10 years. When you review your first quarterly statement, you see that the value of your investment has dropped to $950,000. What would you do?
1) Take advantage of the lower prices and invest more money, if possible, since I am interested in the long-term value of my investment and I’m confident that I have made the right choice.
2) Leave my money where it is, since some changes in value are a normal part of investing.
3) Monitor my investment closely and sell if the value has not recovered in three to four months.
4) Sell my investment immediately, since I’m not comfortable with any decline in value.
Portfolio Manager helps clients deal with emotions
People have varying degrees of being able to deal with the ups and downs of the markets. When the markets decline, some people view this as a buying opportunity while others fear the worst and look at selling. If everyone believed the same thing, then there really wouldn’t be a stock market. There must be both buyers and sellers to make a market. I
nvestors who can handle risk and volatility are typically further ahead. Getting too emotional with your investments can be damaging if you sell quality investments at market lows.
In some cases, the biggest advantage of dealing with a Portfolio Manager is the ability to reduce the psychology factor. If you choose to do it on your own, then you are far more likely to get emotional in your decision-making.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138, email [email protected], or visit .
