How I’ve coped with 40 years of market setbacks

Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

When markets wobble, I remember the serenity prayer. In our investments, as in the rest of our lives, we should: accept the things we cannot change; seek the courage to change the things we can; and ask for the wisdom to know the difference.

In the 40 years since I graduated and first got interested in the stock market, I’ve experienced plenty of setbacks. From the 1987 crash to the bursting of the dot.com bubble, the financial crisis and Covid, there have been things I could and should have done and other things I just had to live with. As the Trump Bump morphs into a Trump Slump, I need to be clear which is which.

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When the market takes a turn for the worse, we are always faced with a bunch of ‘what ifs’. This time around, these are mainly regrets about not reducing even further my exposure to the US. In particular, I could have forced myself to act more decisively on my scepticism about the Magnificent Seven shares, which have led the charge for so long but become too expensive in the process. Having the courage to change what we can is easier to say than to do.

But only with hindsight can we get our positioning just right. In the real world, without a crystal ball, we can only do our best to fix the roof while the sun is shining. And broadly speaking I have done that. My pension, ISA and other investments have always been very broadly diversified, with exposures to the US, UK, Europe, Japan, emerging markets, some bonds, property, infrastructure, gold, and cash. Asset allocation is within our gift. It is always something we can change.

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We recently analysed what would have happened to a portfolio split evenly across 15 different investments, comparing its performance with the same amount invested exclusively in each of them. Over the past 20 years, we found that £20,000 grew to about £90,000 in the diversified portfolio. That was less than half what the same amount would have delivered if invested 100% in the US stock market, but three times what you would have earned if you had invested solely in cash or commodities and more than twice what bonds would have delivered. The balanced portfolio beat nine of the 15 asset classes. Those are odds I can live with.

Accepting what we cannot change is harder. It is made easier, though, by studying the past and understanding that what was hard to take in the moment has always worked out alright in the end. In particular, I find it helpful to realise that corrections are just a normal, unavoidable part of how markets operate. Over the past 100 years or so, the US stock market has been at least 5% below its most recent peak more than half the time (57%). It has been at least 10% below its latest high around a third of the time. And US investors have been 20% or more below the peak a fifth of the time.

The volatility of the stock market should be seen as the price we pay for the long-run outperformance of shares compared with smoother, apparently safer, but less rewarding assets like bonds and cash. Over the long haul, shares have delivered a total return of nearly 10% which compares to around 5% for bonds. That might not sound like an enormous difference. Compound it up over an investing lifetime, however, and it is a very handsome reward indeed for periodic market jitters like those we are experiencing today.

The important thing to realise is that those superior returns only accrue to those investors who can accept short-term volatility and don’t attempt to change what they cannot control. The main problem with trying to finesse the market is that the best days in the market very often follow hot on the heels of the worst. And missing out on just a handful of the best days can massively diminish the long-term returns from your investments.

You don’t just miss out on that day’s recovery. You also miss out on the returns on those returns on every subsequent day of your investing career. It’s an invisible drag, but no less real. It’s important, also, to understand the difference between volatility and risk. The first is just a temporary dip, the second refers to permanent damage that you can never fix.

Part of the wisdom of knowing the difference between what you can change and what you cannot is understanding that the relationship between the two changes over time and according to your circumstances. When you are young, with a lifetime of investing ahead of you, a short-term fall in the market can be viewed with equanimity. It’s an opportunity to buy more investments for the same level of saving. Forty years later, when you are starting to take money out of your investments, the arithmetic works in reverse.

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We recently analysed what would happen to two investors drawing the same income from their pensions for 10 years and experiencing the same calendar year returns but in reverse. One investor enjoyed a sequence of good years followed by some bad ones. The other had the bad years first before returns picked up again. At the end of the decade the first investor had a residual pension pot worth 25% more than their less fortunate counterpart. Same returns, different sequence, very different outcome.

If you are in this situation, the current market wobble will concern you more than it should your children. You cannot do anything about the market’s gyrations. But there are still things within your control. Make sure you have a decent cash buffer to ride things out if this nascent Trump Slump has legs. Be flexible. To the extent you can, live off the natural income rather than dip into dwindling capital. Change what you can. Accept what you cannot.

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This article was originally published in The Telegraph.