MANNIK DHILLON, CFA, CAIA 05-Sep-2018
In late August the S&P500 Index® rallied to an all-time high. Predictably, market commentators and pundits high-fived, and Twitter feeds everywhere cheered another impressive milestone: the longest bull run in history, dating back to the March 2009 lows.
But remember, when times are good it’s best to have a plan for the inevitable downturns. In fact, protracted downturns often incite emotional investing decisions that can have potentially destructive ramifications on returns and long-term investment objectives. But don’t take my word for it. There’s an entire field of Behavioral Economics that studies the effects of psychological and emotional investment decisions. The urge to sell stocks when they go down is very strong, especially during times of tumult. Conversely, investors often don’t have the stomach to buy after the market plummets and losses are fresh in their mind. This is just human nature.
To put it simply, many humans are hard-wired to buy high when everything feels good and sell low when times look bleak, which is often the exact opposite of what many people's investment plans call for. So how can investors save themselves from themselves?
One possible solution is to employ a systematic, disciplined approach that provides exposure to stocks with a built-in mechanism to shift allocations and raise cash depending on market conditions. So when stocks fall to a certain level, reallocating to cash may be an important first step to help limit steep losses associated with protracted downturns. But that’s only half the battle. It’s also imperative for many investors to have a plan to step in and methodically reinvest after stocks go down.
Establishing clear rules and having the discipline to stick to the plan is not easy, and admittedly it’s even harder in turbulent times when we tend to be bombarded with dire news. Fortunately for investors, there are some investment products that may help eliminate the temptation to make emotional decisions. These rules-based products may be appropriate for investors seeking equity exposure with some level of downside management. And they also might help any investors who have become uncomfortable with stock valuations or leery of elevated levels of market volatility. Of course careful due-diligence is important, and investors should not only consider the exit and reinvestment methodologies of such products carefully, but also their associated fees and expenses.