Chill

 By Guest Blogger Doug Rowat

Back in October, as global equities plunged, I sat in my kitchen, despondent, face buried in my laptop, gazing at a sea of red.

My young daughter approached and asked, “Daddy, why did the banana go to the doctor?” Consumed by the market carnage, I just continued gazing. Persisting (don’t even bother trying to ignore a six-year-old), she asked again and then, exasperated by my silence, delivered the punch line: “Because it wasn’t peeling well!”

I finally snapped out of my funk, turned to her and laughed out loud. She did too. In an instant, I was reminded of what really matters and it certainly wasn’t short-term market volatility. But this is what happens when markets dip, even pros like me can become consumed by the upheaval, have brief moments of hopelessness and lose sight of the things that really matter.

And negative months like October create so many traps for investors to fall into—traps that can amplify their despondency. For instance, when markets are volatile, comparative thinking and envious feelings emerge. Ordinary investors often assume that the market forces are only affecting them personally and that other, wealthier investors are significantly outperforming. An assumption is made perhaps that the rich have more sophisticated resources and are magically beating the market while smaller investors are getting left behind.

However, unless your direct competition is Warren Buffett, this is simply not the case. Naturally, many of the super-rich have had spectacular individual business successes or were lucky enough to inherit vast family fortunes, but once the wealth is in place, it often doesn’t grow spectacularly. For example, the net worth of the 400 richest Americans grew only 7% from September 2017 to September 2018 (the latest data range available), according to MarketWatch. Most straightforward 60/40 portfolios could have rivalled this growth. The S&P 500, by comparison, was up almost 15% over the same period. In short, if they’re disciplined, regular investors can compete quite well with the big boys.

However, problems arise when investors aren’t disciplined. First, recognize that your control over markets is, sorry to say, non-existent. The Bloomberg World Exchange Market Capitalization Index, which measures the market value of all the actively traded securities on all the world’s major exchanges, currently sits at about US$72 trillion (with a ‘t’). In other words, capital markets are extraordinarily massive and reflect the decisions of tens of millions of investors. One can’t possibly control an entity so large, or outsmart it through frequent—and usually emotion-skewed—trading.

Dalbar, an independent financial-services research firm, confirms this. Dalbar annually publishes its widely read Quantitative Analysis of Investor Behavior report, which examines real-investor market returns. Basically, the report measures the performance actually realized by average investors versus the performance of a broader, bought-and-held index. Spoiler alert: average investors are shockingly terrible.

Real-investor returns versus S&P 500 – 30 years

Source: Dalbar. Returns to end-2016. Returns include all transaction costs and dividends

Dalbar’s conclusions are blunt: “investors lack the patience and long-term vision to stay invested…. Jumping into and out of investments every few years is not a prudent strategy because investors are simply unable to correctly time when to make such moves.” Warren Buffett would agree. Recall his wisdom regarding making money on the stock market: “I buy on the assumption that they could close the market the next day and not reopen it for five years.”

Frequent trading, particularly in reaction to short-term volatility, is pointless and erodes returns. Help from a financial advisor to control these impulses may be useful and an advisor may also bolster performance or limit downside by occasionally shifting asset weightings or geographies based on prevailing market conditions, but if the advisor is good, these wagers will be modest as even the best portfolio managers are often wrong. Overall, the best strategy is to simply buy quality assets with demonstrated long-term returns and always maintain balance and diversification. It’s your best shot against a US$72 trillion-dollar monster.

So, if you have such a balanced and diversified portfolio, just ignore markets when they’re volatile. You’ll weather these storms. Don’t gaze obsessively at your portfolio every day. Turn off the TV. Close your laptop. Go outside for a walk. And, most importantly, spend more time with the important folks in your life who are probably sitting right in front of you: your family, your friends, or even your dogs and cats.

Well, not your cats. That’s just sad.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.