Key Takeaways
- An understanding of market cycles and the associated risk levels
- Why the longer a client stays invested, the lower the risk of loss will be for a given mix of assets
- The importance of tailoring an investment horizon to the individual client
Most professional market watchers agree that knee-jerk reactions to geopolitics or financial markets should be avoided. After all, your client may be seeking advice in order to buy a second home, plan for their children’s education or plan for retirement. So, planning for the long-term and understanding your client’s appetite for risk are key factors.
Paul Stocks, financial services director at Dobson & Hodge, an advisory firm, says: “The anticipated time horizon is a very important aspect, given that the duration will weigh heavily on the level of risk that we feel is appropriate.
“We also take the view that, broadly speaking, the longer the anticipated duration of an investment, the lower the risk of loss will be for a given mix of assets. Our clients’ requirements are also factored in to help us conclude whether investment risk is appropriate and, if it is, at what level.”
The problem of market timing
S&P 500 Return – 04-Jan-28 to 31-Dec-18
Condition | Average annual return |
|---|---|
All 23,940 days | 9.62% |
Exclude best 10 days | 8.34% |
Exclude best 20 days | 7.42% |
Exclude best 30 days | 6.61% |
Exclude best 40 days | 5.89% |
Exclude best 50 days | 5.25% |
Source: Ned Davis as at 31-Dec-18 distributed with the consent of Miller Value Partners.
This analysis illustrates the significant impact of missing some of the best days of market performance on an investor’s average annual returns.
Investing for the long-term
Recent research1 from financial services firm, Morningstar, indicates that ‘time in the market’ will typically lead to solid results. The report asks the question: “Is there a good time to buy or sell actively managed funds?”
The report concludes that there isn’t. Why? Because most of the positive equity performance over the past few decades has occurred over a few months. Therefore, being out of the market for these critical months can have a severe impact upon overall wealth generation.
Morningstar’s Paul Kaplan says: “Over the long haul, the stock market’s outperformance over cash boils down to a short time period. Miss those months and you will have missed all the risk premium to be earned from holding a volatile asset such as stocks.
“Between January 1926 and October 2018, U.S. large-cap stocks owed their outperformance over cash to just 51 months—less than 5% of the months in the sample. If you held stocks for all 1,063 months apart from those 51 months, which we’ve called ‘critical months,’ you would not have beaten cash.”
Jamie Farquhar, Director at Square Mile Investment Consulting and Research, adds: “Ultimately, the long-term return to the client is key. When an adviser constructs a portfolio for a client, he or she must demonstrate an investment horizon tailored to the client’s needs using essential means like risk-profiling tools or a risk-profiling questionnaire. It’s all about suitability and due diligence in the adviser/client relationship.”
