Financial markets often go through phases of relative calm followed by abrupt and often unanticipated spikes in volatility. It is important for investors to understand that volatility is normal and beyond our control. However, we can control how we react.
Generally, the best reaction is no reaction at all. Pulling out of the market when it is volatile can lock in losses and could lead to missing out on any subsequent rally. Here are six good reasons why staying invested for the long term is almost always the best way to navigate market turmoil:
- Market timing is difficult.
- Selling during a correction is betting against the odds
- The likelihood of negative long-term returns for a balanced portfolio has historically been very low.
- Volatility breeds opportunities
- Market volatility provides an opportunity to rebalance
- Diversification can be most effective when markets are uncertain
Ask the most experienced investors, and many will tell you that drastic allocation shifts in an effort to time the ups and downs of the market is immensely challenging.
As much as any investor would like to avoid market downturns and take advantage of rallies, to do so means getting out at the right time and knowing exactly when to get back in. Without a crystal ball, those are difficult calls to make with potentially adverse effects on your portfolio. Since no market cycle is the same, it isn’t easy to anticipate market movements. All sorts of factors—politics, monetary policy, business activities (such as corporate mergers), and sudden international shocks (such as the global pandemic in 2020, the oil-price shock in the 1970s, and the tech bubble in the early 2000s)—can spark a market reaction.
If your timing isn’t perfectly accurate, you could miss out on potential rallies, which are virtually impossible to predict. The chart below shows that missing even a few days of positive market activity can impact your portfolio.
History suggests that periods of sharp declines have often been followed by periods of some of the most favourable returns. Figure 1 shows the strong returns of U.S. markets during the 12- and 24-month periods following some of the sharpest declines of the past 40+ years. The strong historical tendency of markets to rebound provides some evidence that fear-induced dramatic alterations to asset allocation are unnecessary for investors who simply stay the course.
Figure 1: U.S. equities have bounced back from market shocks
Stocks have historically outperformed bonds when based on average rolling returns over one, three, five, 10 and 20 years. Just as compelling is the traditional ability of a balanced portfolio to produce positive returns. Figure 2 shows that a global balanced portfolio of stocks and bonds has not produced a negative return over any five-year rolling period since 1980. The bottom line is that, although there are no guarantees that the future will resemble the past, history tends to favor long-term investors.
Figure 2: Diversified portfolio has done well in long term
While economic uncertainty will always be a cause for investor anxiety, the resulting market volatility has historically offered active managers in equities and bonds the potential to better position portfolios for the longer term. Markets sometimes get over-exuberant and prices become excessive, but the opposite is also true. Short-term periods of crisis can push prices artificially low, creating excellent opportunities to buy. Russell Investments portfolio managers as well as the independent sub-advisors we hire, can take advantage of temporary mispricing in the market. By doing so, it’s possible to plant the seeds of potential long-term profits during periods of uncertainty
If a crisis creates an opportunity, then portfolio rebalancing is perhaps the best way to take advantage of that opportunity. When comparing assets within a portfolio, rebalancing means selling assets that have gained in value and buying assets that have fallen in value in order to maintain the overall strategic asset allocation of a diversified portfolio. During a market correction, this should result in buying more assets that have decreased in value—an essential part of the process of buying low and selling high. As Figure 3 highlights, an asset allocation that is systematically rebalanced has produced a modest return advantage, but more importantly, has managed risk over time. Systematic portfolio rebalancing is a crucial aspect of Russell Investments’ portfolio approach. In essence, it provides investors with increased exposure to opportunities that are likely to pay off in the long run.
Figure 3: Rebalancing vs. Buy & Hold
Over time, financial markets deal with numerous crises. To name a few over the last two decades, there was the technology bubble, a credit bubble, the U.S. subprime debt crisis, the sovereign debt crisis in the Eurozone, and the economic impact of the restrictive measures governments around the world have taken in early 2020, attempting to contain the spread of the novel coronavirus COVID-19.
One reason to hold a multi-asset portfolio is in part to spread the risk budget across multiple asset classes in order to mitigate market volatility. Having a robust strategic asset allocation with regular rebalancing can potentially enhance returns, but more importantly, manage volatility. However, from a multi-asset investors’ perspective, longer-term returns have been reasonable. For example, the hypothetical globally diversified asset allocation in Table 1 shows solid returns over the long term.
Table 1: Benefits of Diversification – Annualized Return
Where to go from here?
The emergence of the COVID-19 virus in early 2020 is a stark reminder of how quickly trends can shift. Global equity indexes had risen in a relatively steady path for more than 10 years until mid-February. Then, as governments began to shut down international trade, commerce and many industrial sectors in an attempt to contain the spread of the virus, markets retreated sharply. Many key indexes fell to levels not seen since the Global Financial Crisis in 2008. Despite fiscal and monetary stimulus plans to keep economies afloat, markets are likely to remain volatile until the containment measures begin to be lifted.
The extreme swings in financial markets in 2020 may make it hard to stay invested as we watch our portfolios gyrate. But as we have shown, volatility is a normal part of investing, market downturns are eventually followed by market rallies, and history has demonstrated that patient investors have been rewarded over the long term.
- Avoid the temptation to overreact to market movements.
- Reduce risk through proper geographic and asset class diversification.
- Consider multi-asset investing for a more holistic approach geared towards return enhancement but with a natural focus on downside risks.
To find out more, please ask your advisor or contact us at 800-787-7354 or visit us at russellinvestments.com.
IMPORTANT INFORMATION
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets.
The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
The MSCI EAFE Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. is an equity index which captures large- and mid-cap representation across 21 developed markets countries around the world, excluding the U.S. and Canada. With 918 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Countries include Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the U.K.
MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
FTSE EPRA/NAREIT Developed Index: A global market capitalization weighted index composed of listed real estate securities in the North American, European and Asian real estate markets.
Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities (specifically: Barclays Government/ Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).
Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Unless otherwise stated all index data is sourced from ©eVestment Alliance, LLC. All rights reserved.
Past performance does not guarantee future performance.
Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.
Securities products and services offered through Russell Investments Financial Services, LLC, member FINRA, part of Russell Investments.
Copyright © 2021 Russell Investments Group, LLC. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investment Group. It is delivered on an “as is” basis without warranty. First used: April 2020. Updated: January 2021.