Why it pays for fund investors to keep the emotion out of investing

New data shows the importance of ‘keeping calm and carrying on’ when stock markets are volatile.

Few long-term private investors enjoy market turbulence, and this year’s sell-off has been particularly painful for the growth investors with a focus on technology who have had such a strong run for the past two years.

However, the fact is that short-term market movements are an integral part of the whole investment process. The danger is not volatility per se, but how investors react to it.

As Ben Kumar, senior investment strategist at 7IM, observes, the automatic response of many in such a situation is to let emotion take over, “sell up and revert to what they think is safe – cash”, rather than holding on to the rational argument that volatility tends to be short-lived.

Sharp falls and big gains in stock markets tend to cluster together across short periods of time, so the danger is those who hit the sell button are likely to miss out on eventual recovery.

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To prove that point, 7IM has done some revealing number-crunching on the impact of pulling out of the market in the face of turbulence over the 20 years to 31 December 2021.

It finds that if an investor put £100,000 into the FTSE 100 at the end of 2001 and stayed fully invested until the end of 2021, the investor would end those two decades with £295,372, amounting to an annualised return of 5.6%.

By attempting to time the market – going into cash in periods of turbulence and reinvesting later – the danger is missing those key ‘big bounce’ occasions of dramatic recovery.

Thus, being out of the market for its 10 best days during those 20 years because of what Kumar describes as “an emotional knee-jerk decision to sell during periods of volatility” would halve the total return, reducing it to £193,530. And if the investor missed the best 30 days, they would now be sitting on just £62,895 – a capital loss of almost 40%.

As Kumar explains: “Digging into the numbers, 14 of the 20 best days were within two weeks of one of the 20 worst days. Just when you’re feeling most nervous is when a big bounce is likely.”

However, there are lessons to take on board about coping with volatility. As Gavin Haynes, a director at Fairview Investing, comments: “Recent market falls are a good reminder to investors not to be complacent and take on too much risk. The best way to manage volatility is to have a well-diversified portfolio across different markets and asset classes.”

That means not focusing single-mindedly on current runaway growth stories when the market is buoyant, and instead spreading your interests across less high-octane options.

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“There is also a strong argument for also having defensive funds focused on steady returns and capital preservation as part of your portfolio,” adds Haynes. He picks out the highly diversified multi-asset open-ended fund Troy Trojan (-3.2% against the Investment Association (IA) Flexible sector average of -6% over the past three months) as a good choice.

He also likes the similarly defensive investment trust Ruffer Investment Company (LSE:RICA). Its net asset value (NAV) is up 2% over the last three months, against its Association of Investment Companies (AIC) Flexible sector NAV average of -7% and the AIC Global sector NAV average of -11%.

Other highly respected investment trusts also in the Flexible sector and with a strong focus on capital preservation include Capital Gearing (LSE:CGT) and Personal Assets (LSE:PNL) (both with three-month NAV -3%), and RIT Capital Partners (LSE:RCP) (three-month NAV up 3%).

In addition, investors who are nervous about ploughing money into the stock market in the face of current uncertainties could be well served by drip-feeding cash into the market through a regular investment plan such as that available from interactive investor.

It’s self-evident that global economic and political uncertainty is unsettling for any private investor – particularly those who have not experienced volatile markets before. But ultimately, as Haynes is keen to stress, it’s important that investors don’t allow the fear of short-term market volatility to change their long-term investment focus.

“Cash and bond yields remain at low levels, and overall, the potential return from equities continues to look attractive for long-term investors, in my view,” he concludes.