Friday 16 November 2018

Investors should weather market storms and avoid jittery moves

 

Stock image
Stock image

Eoghain Murphy

Investors can find it challenging to filter out market news and stay invested.

There may be plenty of headlines that could cause investors to be anxious and the media can be quick to predict doomsday scenarios and draw comparisons to previous stock market crashes.

Of course, keeping abreast of news is a way of staying informed and developing a perspective on the wider trends that may affect stock markets. However, much of the daily news reporting on political events will not have a major impact on the economy, and therefore simply isn't relevant to investors with a well-diversified portfolio.

Although diversifying a portfolio across multiple asset classes doesn't shield an investor from losses, it may help to balance returns over the long-term if some of your investments rise to offset falls in other areas.

Essentially, news surrounding the stock market is unlikely to reflect the performance of a portfolio that holds a wide range of assets.

It's tempting but dangerous to take the headlines affecting one asset as representative of what is happening to an entire portfolio.

Reacting to short-term news by tinkering with your portfolio and repositioning assets could come at both a financial and emotional cost.

When faced with a heightened sense of risk, one of our first thoughts may be to reduce the risk of our portfolio, or even sell out to shield us from any losses. This is a natural reaction: the typical definition of what's known as 'loss aversion' suggests that we feel losses twice as much as gains of the equivalent size.

However, if this reaction leads to portfolio repositioning, it may not only put a stop to the anxiety investors are (temporarily) feeling - it could also be harmful to one's investment goals as it could stop one being fully invested in the market and cause one to lose out on the potential for long-term gains. Trading too frequently could also have a larger adverse impact than would be experienced by simply holding a portfolio as it stands. One of the classic results in behavioural finance suggests that investors who trade more frequently, on average, earn lower returns.

The effect can be twofold.

Trading frequently can be costly because of higher transaction fees which can erode returns over time. Returns may also be affected by poor market timing - investors have a disposition to hold losing positions longer than winning positions.

It's important to plan for how you may react during a stock market tumble - so that you can limit the damage of such slides. In investing, market cycles are as inevitable as the changing seasons, and we should be prepared to weather them. It can be important to prepare for your emotional reaction to market events.

Maintaining your rainy day savings and focusing on a long-term investing strategy should ensure you are well-positioned for bouts of volatility and changes in investor sentiment.

In choppy markets the availability of bad news and doomsday predictions can very quickly instil a sense that markets are doing far worse than they really are.

A long-term perspective may be lost by the individual investor, as well as the wider market. Ensuring you have a plan which recognises your likely behavioural tendencies can help you manage them should they arise - and avoid the danger of negative news derailing your long-term investment objectives.

Eoghain Murphy is a director at Barclays Private Bank (barclays.ie)

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