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What to do during market turmoil, sell-offs and corrections

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The average investor grew 100K to 305K over the last 30 years, when the stock-market would have grown the same 100K to 2.3M!

Investors have a tendency to react to stock market losses by selling. It’s understandable, it makes the pain go away. You first feel better because in the short-term you may guess correctly and the market continues to fall. Then the markets recover, as they always do, and the result is inevitable: Huge portfolio under-performance.

Here is one of the most important things I learned in my career as an investment professional: the smartest thing to do during periods of market turmoil is to do nothing.

Don’t just do something, stand there!

The latest Dalbar research report[i] on the performance of the average equity mutual fund investor shows the incredible difference in performance between the average investor, based on when they make new investments or withdraw from their investments, and the stock market. It is very common for investors to add to their investments when they are performing well and either not add when they are performing poorly or worse, sell…

Over the last 30 years, the average equity mutual fund investor achieved a return of 3.79% compared to the return of the S&P500 of 11.06%. In a non-taxable account such as an RRSP in Canada or a 401(k) in the US, the average investor turned 100K to 305K compared to the passive market investor that could have turned the same 100K to 2.3M by doing NOTHING.

For many reasons which deserve their own article, I do not advocate index investing but rather a disciplined value approach which forces buying after prices move down and selling after prices move up. However, the main conclusion of the above astounding finding is that for most investors doing nothing is the smartest thing they can do during market turmoil. Even during really scary periods like the crash of 1987, the Long Term Capital Management / Russian Ruble crisis of 1998, the .com bubble bursting in 2000 and the financial crisis of 2008-2009, staying the course paid off.  Even better than staying the course I would add to equities when equities are sharply down.

The Dalbar study cites some nine distinct behaviors, calls them “psychological traps, triggers and misconceptions” that cause investors to act irrationally. They do not use the actual words of fear and greed, words that have been uttered very frequently by our profession and perhaps have lost their meaning. Regardless of what the underlying emotions are that trigger the irrational behavior of buying after stocks have gone up in value and selling after they have gone down in value, the important thing for all of us is to identify this pattern and try to get ahead of it.

Of course we do not want everybody to now become rational investors, we just want our clients, with our help, to behave rationally. We do want other investors / market participants to continue to act irrationally to create inefficiencies and opportunities for us, the rational disciplined value investors to buy low and sell high!

Most sell-offs appear to have really good reasons for happening when they do. The negative messages are repeated constantly by the media and they become more real every day as this repetition makes these reasons sink in and we tend to forget all the positives that usually exist at the same time. The result tends to be an over-reaction to whatever the actual reason du jour is.

In conclusion:

Work with an investment advisor, establish the right asset allocation for you and stick to it during both good times and bad!

[i] DALBAR’S Quantitative Analysis of Investor Behavior 2015 – please email me at constantine@lycosasset.com for a copy of the report – I do not have the rights to publish it but can email it to clients and prospective clients. While I have some issues with the methodology I believe the results are valid, having experienced exactly the same in my dealings with clients over the last twenty years.

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