What happens to my investments when the markets decline?
When markets decline, many investors climb the proverbial wall of worry on the back of fear that they will lose money. Some even take their money out of the market and wait on the sidelines for it to recover.
While it is true that the value of your investments might fall during a market decline, historical evidence shows that the markets have always bounced back over time, resulting in potentially greater gains for investors.
History is on your side
When you invest in the equity markets, you are typically doing so for the long-term. So you should not react to volatility which is merely a short-term phenomenon. Over the long-term, the stock market makes gains on more days than it loses money. Therefore, the value of your investments will potentially increase over the long-term, in spite of periodic short-term volatility.
Diversification reduces losses
You should note that all market sectors do not necessarily decline at the same time. Different sectors move in different directions in different market cycles. Some make gains or remain relatively stable, while others may make losses. Therefore, a well-diversified portfolio typically does not necessarily lose as much value as the market, with winners offsetting losers in different market cycles over time.
Volatility and risk are not the same
Volatility is a normal short-term market behavior that could result in fluctuations in the value of your investment. Risk, on the other hand, is directly linked to the probability of losing money. The amount of risk you can tolerate is based on the degree of change in your investments that you can comfortably withstand during varying market conditions. Naturally, some investors can tolerate a higher level of risk in order to achieve their financial goals – which is referred to your capacity for risk. Typically, your advisor takes into consideration both your risk tolerance and capacity for risk when constructing your portfolio. Therefore, you should not worry about losing money during market declines. That’s why you have an advisor.
Stay focused on your goal
Most likely you do not need the money you’ve invested for another 10 to 15 years or more. Therefore, you should stay focused on your long-term goal rather than worry about market volatility. Research on investor behavior shows that the less you worry about the impact of market volatility on your investments the more likely you will be most happy. But if you keep checking the performance of your investments frequently, you will experience a lot more stress during temporary market declines. And if you jump in and out of the markets because of volatility, you will probably end up doing worse than those who remain invested when the market declines.