Four lenses for looking through market volatility

If ‘time in the market beats timing the market’ is a well-worn expression in investing circles, it is with good reason – it is one investing proverb that is totally borne out by the data. By analysing the transaction data of over 60,000 investors in a brokerage company during the 1990s, Barber and Odean (2000) found that the average after-cost return for investors who traded the most was 11.4%, which compared to 18.5% for those who traded the least, while the market return was 17.9%.*

A material driver of the underperformance was the increased transaction costs associated with higher portfolio turnover, but overconfidence was also a factor. For those more active investors who take a keen interest in their portfolios and who also believe they can time market cycles, the evidence is far from compelling.

“The investor’s chief problem—and even his worst enemy—is likely to be himself.”
Benjamin Graham

Investor takeaway: Decide on a long-term investment strategy with your adviser that is appropriate to your risk appetite and capacity for loss and then just stay the course. The evidence suggests chopping and changing is often a path to lower returns.

The problem of short termism in markets has been steadily getting worse. Evidence from major stock exchanges highlights that investors have become more short-term over time. In the US, the average holding period of a share on the NYSE was around seven years in the 1960s; by June 2020 this had fallen to only six months. Short termism is not something that is confined to end investors either – even the focus of Wall Street analysts is overwhelmingly on forecasting company earnings for only the next one or two years.

“When an investor focuses on short-term investments, he or she is observing the variability of the portfolio, not the returns – in short, being fooled by randomness.”
Nassim Nicholas Taleb

Investor takeaway: The best way to get an edge in an increasingly myopic market, dominated by high frequency traders like hedge funds and day traders, is to take a longer-term view than the market.

Given the strong herding instinct in asset markets, a bout of selling pressure can prompt some investors to question their own investment choices. Why are other investors selling? Do they know something I don’t? Should I be selling too? The evidence suggests the answers to these questions can be surprisingly irrational. In his analysis of the 1987 stock market crash, Robert Shiller demonstrated that when investors were asked why they were selling, many said ‘because everyone else was selling’.◊

In stock markets, groupthink and herd-like reactions can cause share prices to move away from fair values and overreact in both directions. Share prices can get a little ahead of themselves when everyone is wildly optimistic and subsequently get oversold when everybody becomes much too gloomy. For longer-term investors in risk-aligned multi-asset funds, such times are a reminder that it is the outcome not the path that is critical in the patient accumulation phase of building a pension pot.

Investor takeaway: Don’t fall into the trap of copying other investors’ moves, they may have completely different strategies with shorter time horizons, or they may be forced or distressed sellers.

History shows that different assets perform well at different times. However, there is a psychological pain known as buyer’s remorse attached to investing in a chosen asset that subsequently performs poorly. Regret is one of the strongest felt human emotions and it is typically more pronounced the narrower and riskier the investment strategy. Buyer’s remorse tends to be very high (and painful) for those investors with their entire portfolio allocated to a single asset class or equity sector fund when that asset or sector subsequently underperforms.

“More money has been lost trying to anticipate and protect from corrections than actually in them.”
Peter Lynch

Investor takeaway: Multi asset funds can offer a simple but effective way of dealing with ‘buyer’s remorse’. By investing in a range of assets with different risk and reward characteristics, investors can avoid the binary pain associated with putting too much of their firepower in one asset only to see it fall out of favour.