How savvy investors will play market falls

You know it’s been a bad day on the markets when the headlines make comparisons with 1987.

The 12.4% fall which befell Japanese stocks on Monday was, indeed, the worst since ‘Black Monday’. The falls elsewhere - 3% in the US, 2% in the UK - added to investors’ pain, even if they put this week’s dip more in the category of a minor bump than major crash. So far, at least.

Prices have shown some resistance since the start of the week but there remains a nervous feeling to markets and more volatility should be expected.

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For any investor not used to such periods, seeing significant falls in their portfolio can be unsettling. The temptation to take drastic steps to avoid even worse losses can be great, but there are good reasons to think that that would be precisely the wrong move right now.

Seasoned investors will have an entirely different approach.  Firstly, they will view the losses they’ve suffered in the context of the gains that have been made recently. Performance will be specific to each investor’s portfolio but, for example, a fund tracking global indices¹ will have returned slightly more than 12% over the past year, even after the falls we’ve seen. Investing means ups and downs - you don’t get one without the other.

Secondly, they will not have been surprised to see a pull-back in asset prices - they may have even been expecting it. Valuations on stock markets have been rising. By the end of June, using the CAPE (cyclically-adjusted price-to-earnings) measure, prices had reached 34 times earnings in the US, which is 38% above its 15-year average². That makes profit-taking likely and any sign of weakness was sure to be jumped upon.

What’s more, gains this year have been concentrated among a small number of giant technology stocks. Having gained the most, it is these that have suffered the biggest falls. Most investors will have significant exposure to these companies because they account for such a large share of the index. Yes, investors could have turned away from them before now based on their valuations but that would’ve meant missing out on hefty gains. Instead, experienced investors will have held on while also expecting some sudden drops sooner or later.

Thirdly, the savvy investor will tune out of the short-term noise and focus on their long-term goals. If you don’t need your money right away - and investing should never be done with money you might need right away - then you can allow your investments time to recover, which history suggests they will.

Seasoned investors often see market falls as a reason to invest more, not less, and may even decide now is the time to put any cash they have on the side-lines to use while markets level are suppressed. By continuing to invest through periods when prices are falling, investors can improve their outcome in the long term because any money they invest now will buy assets at lower prices, meaning they have more asset to benefit if and when prices recover.

The chart below helps show the effect. It shows the value on £100 monthly contributions made regularly over many years and invested into the FTSE 100. The combined effect of investing through downturns and the tendency for markets to rise over time means even significant market setbacks can be recovered relatively quickly - and then dwarfed by future gains. The Dotcom crash, financial crisis and COVID pandemic have all been highlighted. And note - the 1987 Black Monday crash barely registers as a blip on the chart.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.