Skip to main content

The return of market volatility: How to avoid these 5 investing pitfalls

Digital light display of stock numbers fades into background of unfocused lights.

Key messages

  • Market volatility is normal, it’s back and its ok to be uncomfortable.
  • Over the long term, equity markets typically trend upwards.
  • Stay focused on your financial goals, put headlines in perspective and speak to your advisor.

“Meta, Netflix and Shopify are all down over 30% year-to-date.”

“Higher inflation will wreak havoc on global economies.”

“Equity markets can’t keep up.”

These days, one doesn’t have to look far for articles supporting the case for imminent market doom. With the S&P 500 Index showing double digit total returns in 8 of the last 10 years1 and technology stocks, amongst others, reaching all-time highs, conventional wisdom would suggest tamer equity returns are on the horizon, and with it, more volatility on a go-forward basis. 

While the COVID-19 pandemic sparked one of the sharpest market declines in history, the drop was quickly forgotten by investors as markets rebounded rapidly and sentiment improved. Given this recent recovery run leading up to 2022, it’s easy to forget about market volatility — how it’s normal and a sign that markets are actually functioning correctly

Well volatility is on the rise again as global markets digest the slew of events — the Russian invasion of Ukraine, the ongoing pandemic, government monetary and fiscal policy, inflation fears, valuation concerns and a less than clear outlook for short- to medium-term economic growth.

With all these headlines, it's important to remember that your MD Portfolio is designed to achieve your financial goals with respect to your time horizon (when you need to achieve your goal) and your comfort level with risk and volatility. Additionally, for clients following our tactical asset allocation advice, adjustments are made regularly in response to changing market conditions to take advantage of opportunities or to avoid risks. As always, we will continue to analyze the situation and make appropriate adjustments if needed.

Stay focused on what you can control

Market volatility can be uncomfortable — many investors feel like they can't control it and want to avoid it. It's important to focus on things that can be controlled, like developing an investment plan that minimizes risks while being able to achieve your financial goals, rather than the fluctuations of the market.

Being uncomfortable can often cloud investment decisions with emotion. Investment decisions driven by fear and greed can pose a great risk to not achieving long-term financial objectives. While you can't ignore your emotions, understanding the root of those emotions can help you channel them more productively in times of emotional uncertainty.

On that note, here are some common investing pitfalls that are often driven by emotion and the best ways to avoid them.

Pitfall 1: Focusing on the headlines

Media headlines are not indicators on which to base an investment strategy — the media wants you to consume the content, which often means framing stories in ways that generate interest. Fear sells, market euphoria sells, but steady, long-term returns? Not so much.

While I’m not advocating for you to ignore headlines, they usually cover some of the scenarios that are possible (all while often ignoring all other possible outcomes), it is important to keep your long-term investment goals in focus. It’s normal to worry about short-term equity returns but focusing on your longer-term goals, and by extension, longer-term market performance, can help reframe the way you perceive the situation.

Over the long term, we know markets will have more up years than down. As illustrated below, annual Canadian equity market returns were positive in 52 of the 71 years since 1950. Zooming out even further, Canadian equity market returns over 15-year periods are solidly in the green; since the 1950’s, there has never been a negative 15-year period. 

Risk of stock market loss over time 1950-2020

Bar and pie charts showing risk of stock market loss during one year, 5 years and 15 years between 1950-2020.

All values are represented in CAD. Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment.  An investment cannot be made directly in an index. ©2021 Precision Information LLC, dba Financial Fitness Group (FFG). All Rights Reserved. The reproduction of part or all of this chart without prior written consent from FFG is prohibited.


Pitfall 2: Trying to time the markets

So be mindful that short-term market news can be a distraction that causes unnecessary emotional turmoil and can lead to actions that could be detrimental to your long-term investment goals. Keeping the right perspective can lead to an increased feeling of emotional security and ultimately allow you to make better investment decisions.

Can a lot of money be made by timing the market perfectly? Definitely. Can some money be made when the timing is just a little bit off? Maybe. The window in which market timing can add value is typically very narrow, and the value-add diminishes the further you are from the timing of the inflection point. The one other truth about market timing though is that being off can actually be quite detrimental. By missing the best 20 days over the last 20 years (so 20 days out of 5000 investable days), an investor would have wiped out almost any gains in a typical U.S. equity portfolio based on the S&P 500 Index.

The cost of market timing

Bar chart showing overall summary of return percentage over 5036 trading days, High-low graph showing daily return data over 5036 trading days.

Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © Morningstar 2021 and Precision Information, dba Financial Fitness Group 2021. All Rights Reserved.


Essentially, the human tendency is to strongly avoid losses relative to acquiring potential gains because losses have a greater psychological impact.2 The financial impact can also be quite significant; an analysis of market returns from the 2008 financial crisis shows a significant divergence of outcomes between someone who stayed the course, someone that divested for 12 months and someone who bailed completely.Traditionally, getting out of the market is a much easier decision than getting back into it. As humans we are hard wired to avoid losses. We tend to react at the first sign of potential losses, but take our time, waiting for “clear signals” to come back. This concept is known in behavioral economics as “loss aversion" and was popularized in 1979 by psychologists Amos Tversky and Daniel Kahneman.

The importance of staying invested

Line graph illustrates different among staying invested, exiting the market after one year and reinvesting and exiting the market and investing in cash.

All values are represented in CAD. Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. ©2021 Precision Information LLC, dba Financial Fitness Group (FFG). All Rights Reserved. The reproduction of part or all of this chart without prior written consent from FFG is prohibited.

 

Pitfall 3: Ignoring diversification

One way to help minimize risk in your portfolio is to diversify your investments. Having a portfolio with the appropriate mix of investments can protect it from risks specific to a particular company, industry, market, economy and / or country. Different investments perform at different times so a diversified portfolio can smooth out performance. Diversification is a key component of a portfolio designed to perform through the entire market cycle and not just over the short term.

Holding a diversified investment portfolio is the most sensible way to fund the investment goals that are important to you but it may not provide the same emotional thrill or cocktail fodder as a concentrated portfolio of “hot" investments. Don't give in to this emotional trap as over the long term the only hot investment needed to get you to achieve your investment goals, is a diversified portfolio.

Asset class winners and losers

Heat map depicting asset class winners and losers in the categories of Canadian small stocks, Canadian large stocks, international stocks, Canadian government bonds, Canadian treasury bills and diversified portfolios.

All values are represented in CAD. Past performance is no guarantee of future results. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. ©2021 Precision Information LLC, dba Financial Fitness Group (FFG). All Rights Reserved. The reproduction of part or all of this chart without prior written consent from FFG is prohibited.


It can be stressful when you miss an investment opportunity or when the markets move downwards. An advisor can provide the experience, perspective and level-headedness to help filter out the daily noise and allow you to stay on track over the long term.

Pitfall 4: Not speaking to your advisor

Additionally, they can help you construct your goals and investment strategy if needed and ensure you are adequately diversified. A review with your advisor can give you the opportunity to revisit your plan, ask questions and reassure yourself that you're on the right path despite fluctuations in the market.

Pitfall 5: Setting unrealistic expectations

After a prolonged bull market run, we often have to remind ourselves that markets don't only move up, they move down as well and that both are part of a normal and healthy market cycle. In fact, stock market corrections happen on a pretty regular basis. For example, the S&P 500 Index experienced double-digit pullbacks in 21 of the past 41 years since 1980. Of those 21 years, the market ended the year with a positive return 13 times. In times of financial stress, it is easy to lose perspective on how markets work.

Similarly, in times of bullish market sentiment, it's easy to forget that a diversified portfolio designed to reduce risk while achieving the performance needed to meet your financial goals, won't likely perform as well as the latest speculative investment story or often even the general market during a full manic bull market. The flip side of that same portfolio though is that it will likely protect you better on the downside.

While emotionally it may seem reasonable that your portfolio will capture all of the upside, while avoiding the entirety of any decline, in practice, this is an unreasonable expectation that can lead to poor long-term decision making.

We are here to help

While we can't predict with 100% accuracy what will happen with the markets, we can take steps to prepare ourselves. Before you make an investment decision based on your emotions and the latest market headline, stay calm, remember your long-term financial goals and take comfort in knowing your MD Advisor* is here to help if you need to talk about it or have any questions.

 

1 Source of data: State Street, as of December 31, 2021

2 Source: Prospect Theory: An analysis of decision under risk, Econometrica, Daniel Kahneman and Amos Tversky, 1979

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Jean-Francois Bordeleau is Senior Practice Manager at MD Financial Management. JF is an advisor to MD Advisors and is responsible for educating them on MD's investment standards and principles as well as MD's investment solutions.

Profile Photo of Jean-Francois Bordeleau