The coronavirus pandemic has undeniably affected our everyday lives in many ways and has also hit the global economy and financial markets hard. In a chaotic market environment with extreme daily moves, many investors wonder whether they should liquidate their portfolios as they are flooded by negative sentiment and bad news. Although it is difficult to remain calm under these circumstances, we should always remember that this is not the first time we are witnessing a market crisis and history has shown us that in most cases, rushed decisions may lead to long-term sustainable losses.
To get a better understanding on this, we will examine the case of a hypothetical investor that started an investment policy in late 2019 having a long-term horizon i.e. more than ten years. The policy involved an initial lump sum investment in a diversified global equity fund.
As a result of the pandemic and its effect on global markets, the fund’s unit price has dropped significantly in the past few weeks and the investor is considering to liquidate his investment and realize a loss in the hope that he will avoid further losses on his initial capital should the markets continue to fall.
If he finally takes this action the investor may face the following circumstances:
Scenario 1 – Sell and wait: In the short term, the investor’s decision to sell is correct if the markets continue to fall. His intention is to re-enter the fund at a much lower unit price, in anticipation of even lower prices caused by a global system crisis that goes out of control. However, timing the entry point is extremely difficult and the markets may start recovering much earlier than he expected. As a result, the investor remains placed in bank deposits thus missing the upside because he ends up waiting too long to re-invest.
Result: The loss is realized but not recovered.
Scenario 2 – Sell and re-enter: The investor’s decision to sell proves wrong and markets recover much sooner than expected as a major global recession does not materialize. Disappointed with his decision, he decides to reinvest at a higher unit price than the one he liquidated at initially.
Result: The loss is realized and a complete recovery of the initial investment takes longer.
An alternative course of action that history has shown to work best for long-term investors is the following:
Scenario 3 – Maintain and buy more:
Although the investor is worried about the significant drop in the fund’s unit price, he keeps in mind his long-term investment horizon and does not attempt to time his entry. His financial circumstances have not changed despite the crisis so he goes one step further and decides to take advantage of the lower prices and starts investing additional funds to his investment plan which result in a lower average acquisition price.
Result: The loss is not realized and complete recovery happens sooner as markets recover
So although there is no straight answer to what is the best course of action for an investor, as personal circumstances always differ, it is important that we act rationally at all times. It is important to remember that even during an unprecedented situation like this, you should ignore the noise and ask yourselves the right questions: Is my investment portfolio diversified enough? Is my investment plan still matching my investment horizon, my investment objectives and my appetite and tolerance for risk? If the answer is yes, stick to it. History has proved that, in many cases, market conditions such as the one we are experiencing right now may prove to be long-term investment opportunities, thus maintaining your investment discipline is crucial for the long-term success of your plan.