Lessons Learned from Bear Markets
Lessons Learned from Bear Markets
As we enter into the 10-year anniversary of the “Financial Crisis”, which marked the USA’s most recent recession and a significant market decline, we thought a review of the strategies used and lessons learned in that period would be interesting to look back on. Reviewing lessons learned in tough times is important in our business as we continue to apply those principles today, and important for those who are new to investing and may not have their own firsthand experience to look to as markets turn volatile.
Lesson 1: Diversify assets to mitigate risk
The financial crisis highlighted the importance of smartly diversifying assets to mitigate risk. For example, investment portfolios that were heavily weighted in financial company stocks during this time took a more substantial downturn than a portfolio invested in more balanced manner, across multiple sectors and markets. This larger decline in financials was the result of a slowing economy, a credit crunch, and problems with mortgage assets which these financial companies held. By distributing assets among many different asset classes, regions, sectors and styles, an investor can reduce unsystematic risk and avoid unnecessary volatility.
Lesson 2: Decide on asset allocation before a crisis hits, and stick with it
When we construct an investment strategy for a client, it includes a deep understanding for the client’s wealth goals and the risk and return necessary to achieve them. The strategy also includes the client’s tolerance for risk, meaning their ability to emotionally accept the normal volatility of the portfolio, during good and challenging market cycles. We find this disciplined approach to individual portfolio construction helps to eliminate some emotional aspects of investing, which can result in poor performance.
When there is uncertainty in the market, volatility typically increases. Most often the volatility is short-lived and changes to allocation and risk is unnecessary. But if a well understood strategy is not in place, an investor may react by changing risk at the exact wrong time.
We have found that understanding the cause of the volatility and identifying ways to mitigate risk or take advantage of market opportunities is a much better strategy. By maintaining your overall risk profile, as determined by your personal plan, you can adjust exposure to certain market segments that are particularly exposed to uncertainty, or migrate assets to areas that show value, without over-weighting (see Lesson 1).
Long-term success in investing is accomplished with subtle moves that always support a well thought through strategy.
Lesson 3: Keep the lines of communication open
As with all successful relationships, communication is the key. And especially when times are uncertain. We have found that delivering honest and realistic market outlooks to our clients has resulted in a calming effect and helped avoid emotional decisions that could be detrimental to long term success. This also allows the client to voice their concerns and perhaps communicate changes in their life that may need adjustments to portfolio risk.
It is important to have open and honest communication with your advisor before times of uncertainty and heightened market volatility. This allows you to build a solid strategy to meet your wealth needs and keep you on course when the markets get rough. You should have confidence that your advisor understands your goals and has the skill to make proper adjustments when needed.