What do you do when markets fall?

When the UK equity market lost about 10% between January and February a few clients phoned our financial advisers to ask “should we sell up and move to cash?”

A few weeks later the conversation switched and people were guessing how long until the FTSE (UKX) hits 8,000 points. Now, it’s changed again. Markets are falling and high profile investor George Soros has warned that global politics are threatening to generate “another major financial crisis.” Is he right? Nobody knows.

I’ll let you into a secret: no financial adviser, no pundit, and no fund manager for that matter, can predict the short-term direction of the market. Few still even make that claim. That’s not what investing is about.

A panic move to the supposed shelter of cash may be tempting, but good advisers will almost always tell clients it’s not a move they should make. Understanding why doing nothing is the best answer is the key to successful investing.

Think about that another way: where do you think your market returns will come from? Will they come from your own skilful, expertly-timed buying and selling of shares to win a few % points here and there? In and out, float like a butterfly, sting like a bee?

Or will they come from the everyday underlying business activities of the firms you own? Buy coffee beans for pennies, sell espressos for pounds?

Your answer has a profound implication: if you believe that your wealth will grow over time by your own rapid buying and selling of assets then you are not an investor at all. You’re a trader.

Investors take a long-term view. They set goals; they place their wealth in a diversified and risk-based portfolio; and then they do nothing. The sources of their returns are dividends and capital growth from real businesses. These take time to accrue, and markets move through sentiment cycles often totally removed from the reality of “beans in, espresso out” on the ground.

Traders- especially so-called ‘Day Traders’- focus on short-term price movements. They follow chart patterns. They can buy and sell and re-buy in the space of a few minutes. The source of their returns is their own skill, if they have any.

But many frequent ‘traders’ underperform the patient investors. Someone who invested £10,000 in UK equities from March 1993 to March 2018 would have made £58,755. But if they had tried to trade in and out of markets and missed the 25 best days of investing, they would have just £22,526.

And remember who you’re up against if short-term trading is your thing: large institutions, with hundreds of analysts and armies of traders, can act on new information in milliseconds. Think you can be first to the punch? Good luck with that.

Worse, people who get sucked into day trading with leverage, perhaps using derivatives or spread betting, can see their hobby become a full-on gambling addiction.

It’s fine to be either a trader or an investor, although most are better off as the latter. The real problems arise when people haven’t decided which one they want to be.

They invest in a portfolio with a 20 year timeframe, but then pick up the phone to shout ‘sell!’ whenever markets have a wobble. It’s easy to let the trader in you take over when things look bad. You might be doing more harm than good.

People say that investing is ‘hard’. In a way, they’re right, but not for the reasons many think. It isn’t hard because it requires the investor to put in long hours with charting software and a brokerage account; it’s hard because plenty of people don’t have the patience, the discipline, or the risk tolerance to benefit from the firms or funds they buy. They get greedy in market rises and then they panic in market falls.

Technology designed with traders in mind, like the dealing apps that let you check your wealth second-by-second and sell with one click, aren’t always helpful to long-term investors. How can you take a genuine multi-decade view if you’re constantly looking at the share price?

‘Activity bias’ is another threat. When markets fall some people feel the urge to just ‘do something’, or they don’t understand why the financial adviser they are paying for doesn’t seem to be taking ‘action’ on their behalf. But doing nothing is often the best thing. If your plans, risk level, and strategy were correct yesterday then why are they no longer correct after the market loses some ground? If you really wanted to sell this investment then why have you waited for its price to fall – meaning you get less- before you do so?

If you believe you’re an investor then act like one. Buy broad portfolios, think of the money as ‘locked away’, and check its value once or twice a year if you really must. When the market has a fall, and it will, say ‘how interesting…what’s for breakfast?’.

If you do feel the urge to call your financial adviser then their counsel to relax and wait will be worth what you pay them.

Rick Eling is Technical Director at Quilter.

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

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