Being disciplined and sticking to rules is something that we have been encouraged to do throughout our whole lives. The coronavirus pandemic and resulting government rules have only increased the number of rules and regulations we must now follow. Sticking to these requires discipline.
Though frustrating and restrictive in the short term, these rules will ultimately benefit us in the long run and allow everyone to return to a more normal existence. However, as we all know it is easy to justify breaking or bending these rules for a specific scenario.
The same is true for investing. Having a disciplined approach and following your investment rules will benefit you over the long term. However, it is also tempting to bend or break these rules during times of stress or volatility.
This temptation was especially high in March 2020 as markets experienced one of the quickest bear markets (a fall of 10% or more) in history. The natural reaction was to panic and sell equities to reduce the risk of further loss. Many investors would have reacted to the large drop in March by reducing their exposure to equities and increasing their weight to fixed income or cash.
Using an example of two investors with the same portfolio, both consisting of 60% equity and 40% fixed income, we can see the impact of making a reactive change during this volatile period.
The pink line (Disciplined Investor) shows the result the investor who remained disciplined and stuck to the rules maintaining their original portfolio allocation.
The blue line (Undisciplined Investor) shows the performance of an investor who sold equities, reducing their exposure to 40%, and increased their fixed income allocation to 60% on 16 March (the low point in global markets and the point of most fear and panic).
As you can see from the above, the investor who remained disciplined would have generated a return of 10.80% since 1 January 2020, whereas the investor who changed his or her asset allocation in favour of bonds, would have returned only 5.44%.
To put this in monetary terms, on a £1,000,000 investment, sticking to the rules and not panicking created a difference of £53,608 between the two investors.
Even though the investor who panicked may have reduced the volatility of their portfolio in the short term, they were unable to participate in the recovery fully over the long term.
Global equity markets bounced back surprisingly quickly last year. This was mainly a result of sufficient and timely intervention from governments and central banks, but also the nature of the crisis and it being a known event with a clear solution, rather than fundamental imbalances in the global economy.
In the future, markets are unlikely to behave in the same way and every crisis is different. Despite this, investors would be wise to avoid making rash decisions during times of panic and missing out on the eventual recovery.
Setting up the correct portfolio to begin with, having a long-term view and ignoring short-term noise may be hard for investors to do however, those that are able to exercise discipline are likely to come out on top in the long run.
Written by Sam Chedzoy and 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.