It’s been a nail-biter week on the markets after the benchmark S&P 500 Index plunged by over seven per cent in two trading days.
The long weekend in Canada delayed some of the pain but the Toronto Stock Exchange (TSX) eventually posted a loss of over five per cent.
Most market pundits are calling it a correction, but for many investors saving for retirement, it was a punch to the gut.
It wasn’t the first market correction and it won’t be the last, but the volatility they bring can provide insight into our own fears and expectations. For some investors it might be a wakeup call to ratchet down the risk.
Putting corrections in perspective
As global equity markets struggle to make up lost ground, it’s important for long-term investors to look at the big picture.
Much of the losses have already been recovered this week, suggesting an over-reaction to a mass sentiment that markets were overheating.
Even after the carnage, the S&P 500 remains up by over 11.5 per cent so far this year and the TSX Composite is up by more than six per cent over the same period.
Over the past five years the S&P 500 has increased in value by 81 per cent while the TSX has gained 35.5 per cent.
Much of this week’s rebound can be attributed to a continuation of strong corporate earnings and positive economic fundamentals. The term “correction” is used when expectations exceed these fundamentals and market values are reset.
If you are a long-term investor with a properly diversified portfolio, you can wait it out or buy more at lower prices (buy low, sell high).
Selling low in a panic is a bad idea. To help nervous clients put corrections in perspective, U.S.-based Ritholtz Wealth Management often circulates a long term chart of the S&P 500 Index marking historic events that seemed cataclysmic at the time but have mostly been forgotten.
Those events include the 2010 “Flash Crash”, the 2011 earthquake/tsunami in Japan, the 2013 “Taper Tantrum,” the Ebola virus of 2014, the Brexit vote in 2016, and the 2018 global trade war.
There have been corrections between them that don’t even qualify for a name, which is likely the case with this one.
Even after more memorable events including the 2008 financial meltdown and the 2020 pandemic, major equity markets have regained their losses and advanced to record territory 100 per cent of the time.
Portfolio post mortem
No doubt some investment portfolios have weathered this latest correction better than others. If your portfolio losses are greater than the broader markets and lagging in the recovery, you might have a problem.
The S&P 500 is used as a benchmark because it reflects a diversified portfolio of stocks spanning the major sectors and geographic regions. Canadian investors would normally sprinkle in some big Canadian stocks but the overall losses and returns are similar.
Diversification is one of the best investment hedges available to limit losses while casting a wide net for the best investment opportunities.
A qualified investment advisor can tailor-make a diversified portfolio to match the risk tolerance and return expectations of a client. They don’t always pick winners but the winners should far outpace the losers. A really good advisor will build a portfolio that rides the market when it goes up and stems the losses when it goes down.
Skittish investors who don’t need the full upside of equity markets can lower risk by allocating more of their portfolios to fixed income to cushion the downside.
With guaranteed investment certificates (GICs) currently paying five per cent annual yields, fixed income is a safer way to reach overall portfolio return goals.
A five per cent return is normally lower than long-term returns from equity markets but if you are still rattled by this week’s correction, consider lowering your expectations and nestling more of your savings in fixed income.
