Roné Swanepoel, Business Development Manager at Morningstar Investment Management South Africa, knows that many investors are currently unsure as to what to do in these difficult markets. She recommends biting the bullet and staying the course.

Two years after the March 2020 Covid crash, well known American investment manager Peter Lynch commented that more money has been lost by investors trying to predict what is going to happen during a crisis, than has been lost in the crisis itself.

As with all things unknown and uncertain, it is human nature to speculate how things will pan out. Although we have no actual control over the outcome, being mentally prepared for a certain outcome brings some sort of comfort – especially when it comes to our investments.

For most of us, success in difficult markets looks a lot more like survival – surviving our own behavioural mistakes, avoiding trying to time the market, and staying invested. Investors often hear that they should focus on staying the course: tune out the noise and don’t pay attention to market turbulence and panicked news headlines.

But this is a lot easier said than done when it comes to your hard-earned money. So what should we do when we don’t know what to do?

Remember: cash rarely outperforms over the long term

As investors, we are intrinsically loss averse. Simply put, this means we hate losses more than we love gains.

When markets are turbulent, we often see investors struggle with the “fight or flight” physiological response. Investors are left to choose between staying the course amid the volatility (i.e. fight) or fleeing (i.e. flight) to safe-haven assets and cashing out their investments. More often than not, the latter path is taken.

Global markets have been brutal as we tiptoe into 2022. US equities are on course for their biggest annual loss (in real terms) since 1974. During March 2020 the global market fell by 13,23% ( versus an 8,31% drawdown in April 2022). In April 2022, global bonds experienced their worst month in history.

Investors are rightfully fearful and considering the safety that cash could provide. The below chart illustrates the path of an investor who invested $1 000 000 in the Morningstar Global Growth portfolio (a portfolio consisting predominantly of global equity) 10 years ago.

Staying the course vs a dash to cash

We considered two scenarios:
1. Staying the course: if the investor had stayed invested in the Morningstar Global Growth portfolio throughout the March 2020 drawdown; versus
2. A dash to cash: if the investor decided to disinvest from the portfolio and move the investment to cash.

There’s an adage among investors during market downturns: “Don’t catch a falling knife.” Using cash as a flight mechanism when things get tough is detrimental to long-term portfolio returns.

In this example, a panicked dash to cash would have resulted in a difference in ending value of more than $700 000.

Exhibit 1: Dash to cash versus staying invested

When to buy back in?

If you decide to dash to cash, how do you know when to buy back in?

The three most important words when it comes to predicting the future are most definitely “I don’t know.” Time in the market is generally superior to timing the market and even if you time getting out of the market and into cash perfectly, knowing when to get back in can be very difficult.

Let’s consider a recent example. At the end of February 2020 we saw the beginning of a historic decline in the S&P 500. The market finally reached the pandemic low on 23 March 2020, and a bear market (a decline of more if 10% in the market) became a reality.

Historically, it has been observed that it could take an average of about two years for the market to recover from such a sell-off. This time, however, it happened in just 149 days. By the end of August 2020, the index had regained its strength and reached record highs.

So what would have happened if an investor missed the best days? (If an investor was sitting in cash, and didn’t know when to buy back in…)

Let’s look at an example of an investor who invested $1 000 in the S&P 500, 25 years ago. If the investor had left the investment alone (staying the course), it would be worth $3 949 today. But had they missed only the best 10 days in the market over the 25-year period, they would be left with just over 50% of what they would have had if the investor stayed invested.

Exhibit 2: 25 years, initial $1 000 invested, S&P before fees

If history has taught us anything it is that the best days do come after the worst.

Zoom out and consider the long term

Looking at any long-term historical chart of the S&P 500, the performance line climbs over time. Research has indicated that when investors are shown a history of one-year returns, they allocate only 10% to equities, but when investors are shown a history of 30-year returns, they allocate 90% to equities.

Long-term thinking can, to some extent, be a deceptive safety blanket that investors assume allows them to bypass the painful and unpredictable short term.

Unfortunately, this is very rarely the case. As can be seen in the below graph, it is quite the opposite:  the longer your time horizon, the more calamities, geopolitical events, inflation scares, tech bubbles, great depressions, financial crises, and disasters you’ll experience.

Staying the course pays off

The graph below illustrates two important points:

1. Despite numerous severe drops, the cumulative wealth line shows that $1 grows to $22,580 over this period of 150 years. In other words, staying the course and weathering the short-term movements have paid off for investors.
2. The range in shaded areas shows that some declines are worse than others, and that we cannot predict how long each will/can last.

Exhibit 3: Growth of $1 and the US stock market’s real peak values

So, what do you do when you don’t know what to do? Remember these five points:

1. Cash has not (historically) managed to outperform equities and bonds over the long term.
2. Returns don’t happen in straight lines, and they seldom occur when expected, so it really is about time in the market and not timing the market.
3. The long term is just a collection of short runs, and having a long-term strategy does not exonerate investors from short-term setbacks in markets.
4. It’s vital to leave emotion out of your investment portfolio. Often the most beleaguered investments turn out to be a great opportunity for future returns, as investors can access these investments at a good price.
5. Volatility creates opportunity, and short-term underperformance can translate into a solid, longer-term upside.

Markets are volatile right now and it’s all being driven by interest rates, inflation, and the fear of a slowing economy. The good news is that very few investors are bullish, and good things tend to happen when most investors think they won’t.

Staying the course does not necessarily mean sitting still. It means avoiding bad behaviour, remembering your goals and ensuring your approach is applied with discipline. If your goals have not changed, then your investment strategy shouldn’t either.

This post was based on a press release issued on behalf of Morningstar Investment Management South Africa.