Volatile markets can cause investors to respond emotionally, rather than rationally.
Investing – especially in equity markets – is not always a smooth ride. Following several years of solid market returns, equity market volatility has become the new reality, with many areas of the market alternating between extreme ups and downs. As a result of this volatility, some investors get caught up in an emotional rollercoaster because they’re overly focused on the short term. Their investment decisions become based on either fear of losing money or fear of missing out on high returns.
Investors should focus on their long-term financial goals to weather these short-term storms, because as market history shows, returns have generally been positive over the long term. Here’s how you can benefit by keeping your focus on the long term.
Riding the rollercoaster of short-term equity market fluctuations
Many equity markets experience returns that swing dramatically. But as the graphic below shows, investors’ emotional responses tend to lead to poor decisions about when to take action.
As markets rise, investors often feel like they are missing out. When they finally enter the market, the market rise may be near its end, and they can only watch with dread as markets decline. After suffering losses, investors tend to fear further losses and proceed to sell. This process repeats itself over and over again. It has been said that investors are driven by greed as markets go up and driven by fear as markets go down, but whatever drives investor decisions, the ability to stay calm and rational during volatile markets can be an important learned skill.
Annual cumulative return for the S&P/TSX Composite Total Return Index over 17 years. Source: Morningstar Direct. Data to December 31, 2015. This information is for illustrative purposes only; you cannot invest directly in an index.
Have you been for a ride on this emotional rollercoaster?
While short-term thinking will likely impede your investment success – and your ability to sleep at night – there is a better way.
Staying focused on the long term makes for a smoother ride
Even though market directions can sometimes change quickly and dramatically, over the short term, the cumulative return of the Canadian equity market paints a different story.
Equity markets have historically delivered positive returns over the long term despite bumps along the way. Rather than dwell on current events (whether good or bad), it’s more productive for your finances and your emotional well-being to focus on your longer-term investment goals. Given market trends, you can do this with much more confidence than the daily headlines would lead you to believe.
By setting up a pre-authorized contribution plan (PAC) and investing regularly to take advantage of dollar cost averaging, you can stay disciplined and avoid the emotional rollercoaster of short-term market fluctuations.
To learn more about staying invested and disciplined during volatile times, talk to your financial advisor or visit AGF.com/RethinkVolatility.