Stick to your investment plan, says Vanguard
Investors should be wary of recent talk about new investment paradigms and the need for absolute return portfolios.
Such is the volatility of current markets, says Jeff Molitor, chief investment officer (Europe) of Vanguard Asset Management, “it’s easy to see why some investors are casting about for answers, cures and protection.” Investors should instead focus on a disciplined long-term strategy when building their portfolios.
“The data and theory supporting a long-term equity risk premium are robust, while there is limited basis to support assertions that ‘absolute return’ portfolios will deliver as promised,” says Molitor.
Investors are more sensitive to financial losses than they are happy about financial gains, according to recent research. They can also be driven to herd-like behaviour, such as panic selling on the way down and panic buying on the way up.
Emotion is the enemy of successful investing, particularly when the markets are volatile. “Making big portfolio changes based on emotions is a bad bet,” says Molitor. “Successful investing requires patience, perspective and the discipline to keep emotions at bay. Let reason, not emotion, be your guide.”
But avoiding risk can also be costly. “Historically, 78% of a market’s first-year rebound has generally come within six months of a market bottom. Given the near impossibility of calling a bottom, the opportunity cost of being out of the market at the wrong time could be significant,” says Molitor.
Vanguard’s research has shown the tendency for “excessively rosy forecasts because of overconfidence and excessive extrapolation”, as well as “the resetting of those forecasts to an excessively cautious level in the subsequent market crash”.
Molitor says investors should stick to their investment plan. They have to be focused and disciplined on building a portfolio that reflects their willingness, ability and need to take risk.
“Rebalancing to ensure the portfolio stays true their risk profile requires discipline to take away the problem of emotional decision-making.” He adds that the discipline of a rebalancing approach may seem counterintuitive, particularly when it suggests selling winners and buying laggards.