Market downturns, like the one just experienced during the fourth quarter, provide an opportunity for long-term investors to reassess their willingness to take investment risk. However, it is crucial to not make emotional decisions based upon recent results, and instead stay committed to the risk profile that coincides with a long-term investment plan.
To illustrate the importance of commitment through market cycles, the chart at the top of the article shows how a hypothetical 60% stock 40% bond portfolio may have behaved after recent market crises. As can be seen, the hypothetical diversified approach has yielded positive results after each of the past downturns, even though some recoveries lasted longer than others. We expect commitment to an investment plan will yield similar results over the next market cycle.
Of course, it is appealing to try and to outguess the market, but it can be costly when done poorly. Remember, in order to accurately “time” the market, you have to make 2 correct decisions 1) When to get out of the market; and 2) When to get back into the market. Keep in mind there is little evidence supporting any investor’s ability to do so on a consistent basis.
Instead, we believe the better approach is to maintain diversified portfolios in-line with goals and risk tolerances and stay committed through market cycles.
Larger Image, Analysis Assumptions and Disclosures Graph Source: Dimensional Fund Advisors LLP