Why ‘stay the course’ is good advice for investors
In a thought-provoking article last month, Globe and Mail contributor John De Goey questioned the common investing advice to “stay the course” when the stock market experiences the type of major drawdown we are now seeing. Essentially, he asked, “How can you advise people what to do when you don’t know what is going to happen?”
It is true that no one can ever know what will happen in the future. The precise outcome of any investment in stocks is always unknown. This is one of the reasons no one should invest all their money in the stock market.
For the portion of your assets you have allocated to publicly traded companies, successful investing involves thinking not in terms of certainties, but rather in terms of probabilities – based on what history has taught us. This necessarily means thinking longer-term.
You have no idea what the price of Costco, Royal Bank of Canada or Constellation Software stock will do over the next month, or even year. However, over the next 10 years, if you understand these businesses, you will likely conclude that there is a high probability their economic value will increase substantially – and that the stock price will follow so as to produce an annualized return far higher than the rate of inflation during the same period.
By thinking longer-term you are able to put the odds in your favour. You lose this advantage if you take a shorter-term view.
Mr. De Goey makes the valid point that investors are emotionally affected about twice as much by a loss as they are by a gain. In addition, people instinctively focus on what is happening right now. Psychologists have dubbed the combination of these two cognitive biases “myopic loss aversion.”
In plain English, it’s difficult for anyone, including professional investors, to watch the price of their investments decline for several weeks in a row. For that reason, many investors capitulate and sell when the market falls, presumably with the intention of investing again only when prospects appear brighter.
There are at least two problems with this approach. It’s impossible to know when the market price is about to resume its rise. And, even if you do manage to sell prior to the bottom, by the time things appear to be looking brighter, the stock price will have moved higher.
How do we know that trying to time your sales and purchases doesn’t work? That is what objective studies have shown. For example, Dalbar, an independent research firm, has compared the returns achieved by funds and investors who invest in those same funds. While the time-weighted returns were necessarily identical, the dollar-weighted returns, which reflect sales and purchases, were not. The individual investors did startlingly worse than the funds themselves because they sold when prices had fallen and bought after prices had risen. Over the 30-year period ended Dec. 31, 2021, the S&P 500 index had an annual return of 10.7 per cent whereas investors who bought a fund tracking the S&P 500 index had a return of only 7.1 per cent.
When an adviser recommends that you stay the course, she is advising you to put the odds in your favour. It’s sound advice. You should follow it.
