The stock market delivers attractive long-term returns to investors who are disciplined enough to stay fully invested and weather the volatility inherent in the market.
Multiple academic studies have shown, however, that most investors routinely underperform the long-term performance of the stock market due to their inability manage their emotions in the face of market volatility.
Investors tend to be excessively enthusiastic about investing in stocks when the market is doing well, and then they become overly pessimistic during bearish markets, often pulling out of the market entirely. They buy high and sell low.
In response to this behavior, money managers typically recommend their clients diversify their portfolios into other asset classes, most notably fixed income, but also gold and real estate, among others. Over an extended period, this type of diversification may result in lower absolute returns than an equity-only investment portfolio, but with significantly lower volatility. In addition, this approach may produce a superior risk-adjusted return relative to an equity-only investment portfolio.
Most importantly, a diversified portfolio will dampen the losses when the equity markets are falling, enable an investor to stick to a long term investing plan, and avoid succumbing to their emotions and buying high and selling low. A steady, consistent investment approach is critical to long term success.
Following the market crash of 2008-2009, there was a high degree of interest in investing strategies that were less equity-centric. Plenty of investors at the time pulled their money out of the stock market due to their inability to stomach what was happening to their investment portfolios. Every bear market feels serious, unique, secular, and intractable.
But the bear market of 2008-2009 was particularly frightening because it really did feel like the financial system was on the brink of collapse. The correlation between the stock market, home prices, and job security also became apparent to many investors. For most, these are the three pillars of financial security, and seeing all three crumble together was traumatizing.
Making the case for reducing equity exposure after the past five years is a tough sell for many. However, the lesson of the past is that the best time to hold a well-diversified portfolio is when it is the most unpalatable.
Towards the end of 1999 and into 2000, as Internet stocks were defying gravity and the NASDAQ was reaching all-time highs on a daily basis, anyone making an argument of investing in gold instead of the stock market would’ve been seen as a crank. The opposite was true after the financial crisis, when not including gold in your investment portfolio came to be almost viewed as irresponsible
If you have been envious of the returns in the stock market because you have been pursuing an investment strategy that is more nuanced and balanced than just getting long an equity index fund, now is not the time to capitulate. And if you have been fortunate enough to be heavily invested in the stock market over the past five years, it might be a good time to consider the lessons of history, and consider some alternative, less equity-centric investment strategies.
To learn more about investing with the portfolio managers on Covestor, contact our Client Advisers at clientservices@interactiveadvisors.com or 1.866.825.3005. Or you can try Covestor’s services with a free trial account.
The investments are presented for discussion purposes only and are not a reliable indicator of the performance or investment profile of any composite or client account. Past performance is no guarantee of future results.
