Picture your Future. Save for it by earning 1.5% on a 1-year Term Deposit Account! Learn more.

Morningstar Views: Worried About a Market Downturn? Remember Your Goals.

Key Takeaways

1. Investors should assess risk relative to their goals—and anything that might interfere with attaining those goals must be addressed. Market downturns obviously create friction in this sense.
2. Three key considerations if you’re worried about a downturn:
    a) affirm your goals,
    b) check your portfolio suitability, and
    c) ensure portfolio robustness.
3. Having a robust portfolio rarely shows its benefits in a strong market, but it is critical in a down market. It is something Morningstar Investment Management takes seriously.

Resist a Short-Term Approach to Risk; Take the Long View Instead

Reviewing their financial positions for the year ahead has many investors worried, which is a natural reaction. Risk abounds in 2022—from inflation, to military conflict, to lofty valuations. How do we adjust our mindset to ride out the potential rough times to come? It helps to keep our goals in mind, remember to adopt the long view over the short one, and consider the wisdom of Warren Buffett:

“In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

Buffett has enjoyed a long record of success, and he didn’t create such value by letting immediate concerns and fears alter his approach– nor should you.

The future is unknowable, so the best we can do is to address it in terms of probability and preparation. In assessing probability, however, people are often driven by bias and emotion, emphasising the positive at one moment and the negative at another. That narrow emphasis is likely to be reflected in the rapid changes in price of investments. Over-emphasis on optimism or pessimism leads to price volatility, which is part of being an investor, and enduring volatility is a price we pay for reaching our goals.

One must learn to ride out volatility and avoid giving in to pessimism about risk in the short term. After all, if we allow pessimism to drive us into selling during a downturn, we lock in a loss when we might otherwise have stayed the course and watched our fortunes reverse themselves.

That’s not to say the fair value of an asset cannot drop. It can, and when that happens, previous valuation estimates no longer apply. That’s why we pay close attention to the economic fundamentals of an asset and price it accordingly. That’s investment rather than investor risk.

Do downturns occur? They do—and have done so repeatedly. In fact, we’ve seen the S&P 500 fall by 10% or more 54 times since 1980 alone.  

Image 1 Worried About a Market Downturn Remember Your Goals

Risk in the Small Versus Risk in the Large

That’s why it’s important for investors to reflect on their own experience with risk. One helpful way of doing so is to distinguish between risk in the small versus risk in the large. Risk in the small is how we react to volatility. This is a sensitive area that provokes emotions such as fear and greed, often to our own detriment. Risk in the large is all about long term goals and doing what it takes over time to avoid shortfalls. Most of us know that we must accept some investment risk to reach our desired financial goals.

This way of differentiating risk isn’t new, but it can make a difference, as investors can be significantly better at managing risk in the large (goal attainment) than risk in the small (panicked selling amid volatility). Regarding the latter, the evidence overwhelmingly shows that people tend to act in downturns, mostly to their detriment, with outflows from their portfolio during bouts of volatility. Refocusing attention to think in terms of long-term investing, and to focus on overarching goals, can be a useful antidote to the bad behaviours investors can succumb to in the face of unavoidable volatility

We don’t believe investors need to give in during periods of perceived risk; instead, we can address it and prepare for it. That’s where true downside protection comes in, starting with goals and working our way down to robustness.

Our definition of investment risk (the ‘permanent loss of capital’) is likely the same as yours. We seek to understand risk across the full array of potential outcomes, ensuring that a portfolio has the ability to withstand or overcome adverse conditions.

Investing involves its fair share of adverse conditions, but people seldom talk about having a robust portfolio. Diversified, maybe, but not robust. To us, robustness can be considered in line with this quote from American author and professor John A. Shedd: ” A ship in harbor is safe, but that is not what ships are built for.” 

We believe one of the best ways to control for risk is to buy fundamentally strong investments with attractive valuations. But of equal importance is having different risk and return drivers that can weather unpredictable storms to maximise the likelihood of achieving your goals. This can conceptually be applied in a multi-asset portfolio, or when combining multiple portfolios together (achieving more than the sum of the parts).

How Would the Average Investor Summarise the Key Risks in 2022? 

Let’s now get practical and apply this to the 2022 landscape. The below infographic presents a decent capture of the key event risks and fundamental risks investors face as we enter 2022. We will otherwise re-label them as the reasons most people are scared to invest. 

Image 2 Worried About a Market Downturn Remember Your Goals

Of course, any one of these risks could materialise into a market setback, and no investment loss is good for an investor. This is especially the case for investors with shorter time horizons or those nearing retirement. (Sequencing risk means a big investment loss at the start of retirement and this can have a material impact on income levels from that point on.) But that doesn’t mean we should run for cover every time new risks surface.

Investor behaviour isn’t always rational, and people tend to approach markets with overconfidence and a vividness bias. This tends to really show itself at extremes, and especially in down markets.

Practical suggestions to alleviate anxiety about investment losses can be found in the field of decision sciences. Perhaps one of the easiest and most powerful ways is to simply reaffirm your goals before making any decisions. From a behavioural standpoint, people may be more successful when assessing risk in the large, and that reframing can act as a stabilizer.

Another is to look at your portfolio under the lens of robustness. If you take comfort that your portfolio can stand up to many different scenarios (think all-weather) then accepting some volatility is much more palatable and a pre-requisite for good returns.


Morningstar Disclaimers:

Since its original publication, this piece may have been edited to reflect the regulatory requirements of regions outside of the country it was originally published in. The Report is distributed by Morningstar Investment Consulting France SAS, authorised by the ACPR. Registered identifier 89634.

The opinions, information, data, and analyses presented herein do not constitute investment advice; are provided as of the date written; and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this document. Except as otherwise required by law, Morningstar, Inc or its subsidiaries shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. It is important to note that investments in securities involve risk, including as a result of market and general economic conditions, and will not always be profitable. Indexes are unmanaged and not available for direct investment.

This commentary may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

The Report and its contents are not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Morningstar or its subsidiaries or affiliates to any registration or licensing requirements in such jurisdiction.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Morningstar, Inc. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or
solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your
investment return therefrom. Any decision to invest should always be based upon the details
contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta)
plc.

Share on facebook
Share on linkedin

Latest news articles

All News

BlackRock Commentary: Sour Fed growth view not dour enough

Many central banks, like the Fed, are still solely focused on pressure to quickly get core inflation back to 2% without fully acknowledging how much economic pain it will take in a world shaped by production constraints.

Notes from the Trading Desk - Franklin Templeton
All News

Notes from the Trading Desk – Franklin Templeton

The Federal Reserve (Fed), the Bank of England (BoE), the Swiss National Bank (SNB), Norges Bank and the Riksbank all raised interest rates last week and paved the way for further hikes at upcoming meetings.

All News

BlackRock Commentary: Sticking with reduced risk taking

Business activity is slumping and higher inflation persists. Central banks are responding with aggressive rate hikes without fully acknowledging the growth damage. The new regime of macro volatility is taking root with weaker growth, persistent inflation and volatile markets.

Experience better banking

The sooner you start managing your money, your way, using the best-in-class tools, the sooner you’ll see results. Sign up and open your account for free, within minutes.

Login

We strive to ensure a streamlined account opening process, via a structured and clear set of requirements and personalised assistance during the initial communication stages. If you are interested in opening a corporate account with MeDirect, please complete an Account Opening Information Questionnaire and send it to corporate@medirect.com.mt.

For a comprehensive list of documentation required to open a corporate account please contact us by email at corporate@medirect.com.mt or by phone on (+356) 2557 4444.