The impact of compoundingIn relation to the first, the US stock market fell by 13.7% in the fourth quarter of 2018 but has since rallied by 13.9% this year so far (as of 12 April 2019). 13.9 is more than 13.7 so that means investors are up overall, right? Wrong. Investors are actually down by 1.7% over this period. This very common mistake arises because people often prefer to add numbers together in their heads but investments compound from one period to the next.
Keeping your investments balancedTurning to the second common error, think back to the end of 2018. The fourth quarter was a horrid time to be investing in the stock market. There was no hiding place as everything fell sharply. Sentiment was rock bottom and the emotional response would have been to sell. However, partly as a consequence of the market declines but also because earnings grew strongly in 2018, earnings-based measures of valuations had fallen to their cheapest levels for several years. Although valuations are usually a poor guide to short term performance, markets rallied sharply from that nadir. As well as the US market being up 13.9%, Europe, the UK and emerging markets have all risen by around 10%. Even the laggard, Japan, managed almost 8%. With hindsight, it would have been a great time to invest. But, we are hard-wired as emotional beings so overcoming the urge to sell is not easy. Getting over our tendency to extrapolate the recent past into the future takes discipline. One relatively easy way to take emotion out of the equation entirely is to follow a rebalancing policy.
For example, decide (or use an independent financial adviser to help you decide) what percentage of your investments you want in the stock market, bonds, cash and so on. If one asset class outperforms the others, its weight in the portfolio will rise. Rebalancing involves selling some of that winner, to bring its weight back to where you intended it to be, and reinvesting the gains in assets that have performed less well. This is “buy low-sell high” in practice. It’s not rocket science. And it could have resulted in you buying equities at the turn of the year, even though the voice in your head may have been telling you to do the opposite. Again, if ever unsure whether an investment is suitable for you, seek advice from an independent financial adviser. Of course it is true that markets may have continued to fall but valuations are one of the best indicators of long term returns. Long term investors should heed their messages. Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.