An Emotional Perspective on the Market

The last few months have been a roller-coaster of returns, and what a difference a quarter makes.  It is hard to forget the sinking feeling we had in the last quarter of 2018, when the share market fell 9.27 per cent between the start of October and the end of the year.

One of the things I have found having been an investment adviser over so many years, is that investors don’t react to the percentages, rather they react to the gut-wrenching feeling they have when they see their portfolio value fall.  This is an important distinction, because many people who work in financial markets every day can become desensitised to market volatility.

As advisers we are trained to look through markets and place our focus on the long-term outcome we are seeking to achieve for our clients.  Our job when markets get shaky is to keep investors strapped in for the ride. Like a turbulent plane trip it might be uncomfortable, but it is safe.

The last six months has been a very timely reminder of this.  Markets have been on a long recovery since the GFC and this has resulted in the longest US Bull market in history.

But back to what investors feel during periods of market volatility.  Far from tracking the progress of a market index, investors watch their account balance.  To illustrate their feeling more accurately, I have plotted the progress of a $1 million portfolio invested in the All Ordinaries index.  On 1 October 2018, the portfolio was a neat round million – then came the volatility.

By 25th October our investor’s paper loss was sitting at $84,733, a confronting number, particularly for a newer investor.  Then by 20 December the portfolio hit its lowest point, $879,320.  This represents a market fall of 12 per cent, or in ‘investor language’ – $120,680.  That would be hard not to react to.

Figure 1: S&P/ASX – All Ordinaries Index represented by a $1,000,000 Portfolio.  (1 October 2018 – 24 April 2019) |Data source:  ASX    Analysis: Capital Partners Consulting Pty Ltd

The chart shows the portfolio value through the dip and back up to 24 April. What is so evident in the chart is just how devastating a sell decision would have been for our investor had that decision been made on 20 December.  A sell decision would have vindicated the ‘do something’ response to a perceived crisis, and yet that same decision would have excluded our investor from the recovery that has happened since.

I often feel for investors, particularly new people to the investing scene.  The first time a market shakeout hits the emotions kick in.  All they can see, and feel, is their hard-earned capital seemingly disappear before their eyes.  Despite all the logical explanations from their adviser I can understand why it is so hard to stay seated with the seatbelt fastened.

When building a portfolio, a key role an adviser plays is the management of outcomes and expectations.  The questions we consider are:

  1. How much volatility will our investor be able to tolerate in a crisis – At what point will they struggle to remain invested?
  2. How much market risk does our investor really need to take to achieve their goals – If they can achieve their financial and life goals with less risk, is this an appropriate course?
  3. How much market risk is our investor able to take – what is the risk that a severe market down turn could result in failure of their financial plan?

The answers to these questions combined with a robust financial plan really set the investor up for success.

Market cycles vary enormously and coming to terms with volatility is critical to a successful long-term investment experience.  As legendary investor Benjamin Graham once said:

“In the short run, the market is a voting machine. In the long run it is a weighing machine.”