The antidote to market volatility

Editor's Note

This article is sponsored by RBC Dominion Securities

It’s tough not to be a little worried these days. Between rising threats of inflation, new strains of COVID-19 on the horizon and the terrible events unfolding in Ukraine, we all have good reason to be concerned about where our world is headed, and what it might mean for our hard-earned savings. For many investors, those fears and anxieties are translating into the temptation to sell everything and head for the hills until things start looking better. But in my 30+ years in the financial services industry, if there’s one thing I’ve learned, it’s that cashing out and running for cover is almost never a viable strategy.

Whether it was the tech bubble of 2000, the financial crash of 2008 and 2009, or the COVID flash crash of March 2020, history has shown us time and time again that the markets tend to bounce back from almost any downswing long before the headlines start sounding the “all clear” signal. If you cash out now and miss the chance to buy back in before the markets head upwards again, you could be at risk of inflicting irreparable – and possibly devastating – long-term damage to your portfolio.

That said, the challenge of coping with the anxiety that comes with market swings is no small task. The pressure only gets worse if you’re close to, or already in, retirement. Investors who are just starting out are much better positioned to recover from short-term dips. But if you’re in or approaching your retirement years, you may not have the time or earning power left to recoup any permanent losses.

Thankfully, in my experience, the best tool to deal with market volatility has never been trying to time the markets. Over the long run, the markets go up about 75 per cent of the time and down only 25 per cent of the time. This means that, just like betting against the house in Vegas, the odds are seriously stacked against market timing as a long-term strategy.

Instead, I advise my clients to spend less time and energy obsessing about the things they have no power over, and focus more on those things they can control. This includes making sure you have a solid, well thought-out financial plan, and the discipline to stick to it even – or especially – when it seems like everything else in the world is spiraling out of control.

While having a financial plan won’t prevent market volatility from happening or keep you from getting nervous when the pundits are warning that the sky is falling, it can give you a way to re-frame some of the issues that are at the root of those anxieties. Take the crash of 2008-2009 as an example. Fueled by things like subprime mortgages and credit default swaps that most people hadn’t even heard of just a few weeks earlier, markets around the world dropped by 50 per cent or more virtually overnight. This was a truly seismic event in the financial world, and for anyone who lived through it, there was no way to feel calm or carefree about what (at the time) seemed like the beginning of the end for global markets.

For people who still had lots of time before retirement, the right thing to do was to hold fast, or even take advantage of the unprecedented opportunity to invest more money at rock-bottom prices. For investors who were about to enter retirement or who were already retired, however, the sudden drop in the value of their portfolios initially seemed insurmountable.

Yet even for those clients who were most vulnerable to a rapid downturn, when we looked at what their financial plans were actually meant to do – namely, create enough income for them to live comfortably in retirement for the rest of their lives – the question became not what they could do to avoid losses at any cost, but rather could they still generate the income they needed until the markets bounced back, without liquidating everything they’d worked so hard to save?

By thinking about things from the point of view of solving an income need, we suddenly saw several viable options that we may not have otherwise considered. For instance, some high-income investments such as preferred shares, high-dividend common stocks and funds that invested in commercial mortgages had lost half their value along with all the other stocks, making them highly attractive investments. Some of those shares were offering yields of up to 10 per cent or more.

As we quickly found out, the answer to the question of whether we could create the income our clients needed to support their financial plans turned out to be an unequivocal “yes.” At the same time, it was equally clear that selling all their stocks and switching to cash or bonds would have had the exact opposite effect, and might well have set their plans back for another 10, 20 or 30 years.

The happy ending to all this anxiety and uncertainty was that those clients who stayed invested during the worst turbulence the markets could dish out were still able to realize the income they needed, while leaving the capital value of their portfolios in place to recover – and eventually reach new heights – along with the rest of the markets.

This isn’t to suggest for a moment that those were not stressful times, or that any of the crises we’re facing today aren’t real. What it does illustrate is how having a financial plan that articulates your goals and spells out how you plan to achieve them can help you frame any challenges that come along in a way that is far more pragmatic, productive and effective than simply reacting out of fear, or making a decision in the heat of the moment that you might regret for the rest of your life.

This article is supplied by Alan MacDonald, an investment advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.