Out of Practice

Traditionally, January is the time of year everyone signs up for a new gym membership or takes up running again to try and shift some of the excesses of the festive period. Though well intentioned, having usually done very little exercise for the best part of a month, this sudden change in activity can come as quite a shock to the system!

We are currently experiencing a similar phenomenon in markets. The volatile start to 2022 is in stark contrast to the particularly calm and positive market environment of 2021.

By looking at the volatility of the FTSE UK Private Investor Balanced Index, we can see just how tranquil markets were in 2021.

The standard deviation (a measure of volatility) for the index was 4.7%. This is the lowest reading over the last 30 years and almost half the average standard deviation measurement of 8.9% over the same period.

With this context in mind, it’s no wonder that the recent volatility in markets is having an outsized impact on investor sentiment. Quite simply, we aren’t used to it, and we are out of practice, so it is a shock to the system.

One of the best ways to limit the chance of making costly behavioural mistakes during these times is by having a well-diversified investment strategy supported by a robust process.

Even with this in place, volatility can still impact on investors’ psychology so in addition we should remind ourselves of the following to add further context:

Volatility is not risk. Short term fluctuations in markets are a feature not a bug. The only reason you get higher returns over the long run is because you occasionally experience losses in the short term. The real risk is inflation which silently eats away at capital over the long-term if not generating a sufficient return.

We should expect stock market corrections. The S&P 500, the main US equity index, has experienced 36 double digit corrections in the last 72 years (from 1950). This means on average there is a double-digit correction of 10% or more every two years.

Corrections don’t detract from long-term returns. Using the S&P 500 again, the average drawdown (peak to trough) from 1950 has been -13.6% during a calendar year. Despite this, over the same period the S&P 500 has generated an annualised return of over 11%.

Diversification and sensible investing create a more comfortable experience. Our aim is to manage client money in a way that limits their likelihood of making sub-optimal investment decisions. One way we can do this is via appropriate diversification which can soften the impact of drawdowns in specific markets or sectors. Please see the below table to show the drawdown in a balanced portfolio compared with several other more concentrated assets (04/01/2022 – 24/01/2022).

Ultimately, over the last year, it has felt like investing is ‘easy’ and any deviation from this was always going to come as a shock.

However, those who are invested appropriately and have a suitable plan attached to their investment strategy will be well-equipped to weather this volatility and ultimately benefit from higher returns in the long run.

Written by Jonty Brooks

General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur