To Stay or Not to Stay…is That the Question?
For centuries, people have modified Hamlet’s famous “To be or not to be” soliloquy as they’ve explored important options in their lives. This thoughtful exploration often occurs when long-held beliefs are challenged, and the ramifications are significant.
From time to time, financial markets experience significant disruptions, challenging the ‘rules of thumb’ and ‘core beliefs’ we typically hold. For many investors who experience significant losses in their portfolios, it may seem tempting to eliminate their market exposure temporarily, avoid further losses, and re-establish their market presence once things stabilize. The market dislocation of 2022, where both publicly traded equities and bonds posted significant declines over the first nine months, has many investors considering their options.
Should I Stay Invested in the Markets?
This is one of the most common questions investors ask, and for good reason. No one likes losing money, and the prospect of losing more can feel even worse.
The Casino Player’s Dilemma
Consider a late-night casino player as a metaphor. Many of us have spent time at a casino, perhaps playing roulette, blackjack, or a slot machine. Like investment markets, sometimes we’ll go on a winning streak and build up some earnings. While some might walk away at that point, pocketing the winnings, most continue to play, often seeing their winnings erode and sometimes even losing the original amount they brought to the table.
So, what should the late-night casino player do after a run of losses?
If they keep playing, they might win their money back… but they might also lose more.
If they walk away, they’ll crystallize their losses. Is that a better choice?
Some might conclude that the right answer is to walk away since the overall odds favor the casino. Statistically, that’s true, as casinos thrive because the potential for satisfaction (and big winnings!) is so appealing.
Why the Casino Player’s Dilemma is Different for Market Investors
Like casino players, market investors will experience periods where their investments increase in value, erode, and incur losses. Over the first three quarters of 2022, investors who weren’t well-diversified may have suffered double-digit percentage losses; a typical Canadian retail balanced fund was down more than 17% through September 30th, while the typical WealthCo balanced investor was down only about 3-4%.
There are crucial differences between the casino and financial markets. A casino is a game of chance with odds favoring the house, whereas financial market investments are structured to increase in value over the long term.
Perhaps the most important difference is the impact of ‘sitting out’:
When the casino player returns the next day or on their next vacation, their odds remain the same as when they left.
When the uncertain investor returns, their outlook for future returns is often lower than when they exited the market.
Successful Market Timing is Really, Really Hard
Empirical evidence, academic theory, and behavioral psychology considerations do not support the merits of market timing. Studies consistently show that investors who decide to ‘sit out’ are more likely to end up worse off than those who remain fully invested. Unlike the casino, academic theory supports remaining fully invested (and even increasing market risk) during market downturns because relative valuations are cheaper, and long-term return expectations are positive.
The behavioral psychology component of the ‘should I stay’ dilemma is perhaps the most compelling (or frustrating, depending on one’s point of view). Investors who exit the market almost always wait to return until markets have recovered well beyond the point at which they exited. They rarely have the conviction to get back in at an even lower point. As a result, behavioral investors tend to end up with lower returns over the long term.
Our Current Assessment of Financial Markets
As we enter the fourth quarter of 2022, expectations for the broad market economy remain pessimistic:
High inflation remains a problem, leading to…
Expectations of further increases to short-term interest rates, resulting in…
Anticipations of a recession, leading to…
Significant declines in stock market values in anticipation of bad news.
What does all this mean? We believe that both the bond and equity markets have likely overreacted to the impact. Go-forward returns will depend on whether the ‘news’ (e.g., how high interest rates go) is better or worse than currently expected. Will short-term interest rates rise? Yes. Will we have a recession? Probably. But unless interest rate increases are much greater than current expectations or the recession is much deeper than anticipated, we believe that go-forward return expectations for both bonds and equities are reasonably strong, especially over the mid to long term.
So… Should Investors Get Out of the Market?
As we enter the fourth quarter of 2022, our recommendation remains consistent:
“We recommend that the portion of your investment account you plan to use over the next 6-18 months have little to no market risk (i.e., invest in cash or high-quality short-term fixed income). But the portion of your investment account with a horizon of three years or more should be fully invested in a diversified manner with a risk profile that suits your situation.”
We don’t know what short-term market changes will be. No one does. We expect day-to-day volatility to remain high, both on the upside and downside. We expect both bonds and equities to recover, but like all market participants, we don’t know when that will start, and we won’t know for sure until the recovery is well underway.
We continue to believe that a portfolio with ‘real’ diversification (50% public markets, 50% diversified alternatives) remains the best path forward for long-term investors. This combination has served our investors well over the last few years, and we believe it will continue to do so.
About the Author | Dave Makarchuk
This Market Commentary is written by WealthCo Asset Management's Chief Investment Officer, Dave Makarchuk. Dave brings over 20 years of institutional investment experience to the WealthCo team, along with several credentials including CFA, FCIA, and FSA designations.
When he’s not using his critical thinking and problem-solving skills to enhance WealthCo’s investment portfolios and improve investor outcomes, you’ll find Coach Dave on the ice, training the next generation of Canadian hockey players.
If you have any questions or would like to discuss your investment strategy, please feel free to contact us. We’re here to help you navigate these challenging times with confidence and clarity.
WealthCo Asset Management is a member of the Integrated Advisory Community and The WealthCo Group of Companies. The WealthCo Group of Companies works exclusively with Canadian CPA professionals and their clients through the Integrated Advisory community. With over 20 years’ experience collaborating with progressive CPA's and industry specialists, we are dedicated to working alongside our accounting partners to offer a holistic and integrated wealth planning experience to their clients. Please note, past performance is not indicative of future results.