Risk. Many financial commentators and industry professionals agree it is one of the most important considerations for any investor.
In our review of financial media, we see near-constant coverage of it—particularly the risk of loss. Commentary often dwells on the potential for current events to drive equity market declines, warning risks lurk. We, too, think it is important for investors to consider the risk of portfolio declines, including their ability to withstand them. Yet, in our view, considering only this form of risk could be short-sighted for investors whose money must be invested for a decade or more to reach their financial goals—or, in other words, for investors with long time horizons. For long-term investors seeking to grow their assets over time, we think it is helpful to keep another risk in mind—the risk that you fail to earn high enough returns to reach your long-term investment objectives.
We aren’t here to bash financial media, which does provide investors a wealth of information. However, we think it is important to understand how business conditions in the increasingly competitive media landscape can influence the tone of its equity market coverage—and how this, in turn, can influence investors’ decision-making. Between the Internet and cable television, investors have more news sources than ever before. Blogs and other websites provide stiff competition to traditional financial newspapers and magazines. Hence, competition amongst media outlets is fierce.
Throughout history, media providers have found time and again that bad news sells, and the more urgent the headline, the more readers it attracts. This provides an incentive to sensationalise coverage of market volatility and current events and emphasise seemingly negative developments over positive ones. We think it also incentivises media to dwell on potential downside risks in order to keep readers coming back. The intersection of these trends, in our view, often leads to outsized coverage of temporary downside risk factors and mild market volatility. Whilst investors often receive useful information from this media scrutiny, the drumbeat of short-term risks can condition investors to focus on the near term, potentially to their own detriment.
Volatility is a normal part of investing. A risk-free investment with richly rewarding returns doesn’t exist. But for anyone investing in order to achieve growth over the next 10, 20 or even 30-plus years, shorter-term wobbles generally have little influence on their portfolio’s longer-term cumulative return, which we think is what ultimately determines whether they reach their goals. We say this because despite some quite painful short-term declines, equities have historically delivered strongly positive returns.[i] Yet focusing on short-term volatility and the risk of loss could result in making investment decisions that reduce the likelihood of reaching your long-term goals. One manifestation of this could be giving in to the temptation to sell during a correction (a sharp, typically short-lived sentiment-driven drop of -10 per cent or greater) or long after a bear market (a longer, deeper, fundamentally driven decline of -20 per cent) has begun. Though potentially avoiding more downside might feel comfortable, it transforms paper losses into realised losses and raises the risk of not being invested when the market recovers, which can be a large setback.
Another example might be trying to reduce your portfolio’s short-term volatility by increasing your allocation to cash and fixed interest. This might reduce near-term volatility, but it may also reduce long-term returns if historical trends hold in the future.[ii] If reaching your investment goals requires your assets to grow over time, perhaps to help provide for you during retirement, earning a lower long-term return could jeopardise your ability to fulfill your objectives.
Considering the risk of not reaching your goals may sound like an abstract concept, but we think it can be easy to apply. When considering a change to your asset allocation—the proportion of equities, fixed interest, cash and other securities in your portfolio—ask whether doing so might force you to dramatically reduce your cost of living in retirement because your pension pot may not earn a high enough long-term return to provide the level of cash flow you initially planned on. When you feel tempted to make portfolio changes after experiencing a spurt of market volatility or reading about the latest supposed downside risk for equity markets, ask yourself how likely it is that a short drop that soon reverses will seriously affect your total portfolio value several years or even decades from now, depending on your time horizon. For example, earlier this year, we saw headlines frequently warn the UK’s economic slowdown was a risk. But we have seen the same repeatedly since June 2016’s Brexit vote—and even before, like the widespread 2012 fears of a double-dip recession. What if these headlines again prove wrong? How long will you stay out before regaining confidence? How much gain are you comfortable missing in that scenario? Ask yourself: If I sell after a 10 per cent drop and end up missing a 10 per cent or even 20 per cent rally before I get back into the market, will I have helped myself reach my investment goals?
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in equity markets involves the risk of loss and there is no guarantee that all or any invested capital will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world equity markets and international currency exchange rates.
[i] Source: Global Financial Data, Inc., as of 5/9/2018. Statement refers to the FTSE All-Share Index annualised return including dividends, January 1930 – August 2018. The annualised return is the annual rate of return that would ultimately yield the index’s cumulative return.
[ii] Source: Global Financial Data, Inc., as of 5/9/2018. Statement refers to the FTSE All-Share Index annualised return including dividends and the annualised return of the 10-Year Government Bond Total Return Index, 31/12/1932 – 31/12/2017.