Surviving Market Volatility: Lessons from Past Drawdowns
The world is currently experiencing a significant shift in economic dynamics due to the COVID-19 pandemic. The outbreak has caused widespread panic and uncertainty in global financial markets. As an investor, it’s natural to feel uneasy about the current state of affairs.
However, history has shown us that market volatility is nothing new. In fact, drawdowns are a common occurrence in the stock market, and they happen more often than we realize. The key to surviving market volatility is to understand past drawdowns and use that knowledge to make informed investment decisions.
In this article, we will examine past drawdowns and compare them with the current coronavirus-induced drawdown. Additionally, we’ll provide tips on how investors can manage their investments during this time of uncertainty.
Understanding Drawdowns
A drawdown refers to a decline in the value of an investment from its peak value. It’s important to note that not all declines are considered drawdowns; only those that exceed a preset percentage threshold count as a drawdown.
For instance, if an asset declines by 10% or more from its peak value, it’s considered a 10% drawdown. The severity of a drawdown is measured by its percentage decline from peak value.
Historically, there have been numerous instances of significant market drawdowns caused by different factors like war or recession. However, these declines tend to be temporary and usually followed by recovery.
Comparing Past Drawdowns with Current Situation
According to Jeff Mortimer from BNY Mellon Wealth Management, the latest coronavirus-induced bear market might lead investors towards fear-based decisions about their risk portfolio. However, it is essential for investors to assess the situation based on historical data and avoid making sudden moves that could hurt them in the long run.
Mortimer compares recent events with previous instances where markets experienced severe downturns such as the 2008 financial crisis, 9/11 terrorist attack and the collapse of the dot-com bubble.
In each of these instances, market declines ranged from 30% to over 50%. In contrast, the current drawdown has so far seen a decline of around 20%.
Recovering from Drawdowns
The recovery period for a drawdown varies depending on its severity. For instance, if an asset experiences a minor drawdown of up to 10%, it can recover within weeks or months. However, a severe drawdown that exceeds 30% can take years to recover.
It’s important for investors to remember that panic-selling during a drawdown is never advisable. While it may seem like a rational decision at the time, selling off assets during a market dip could lead to significant losses in the long run.
Instead, investors should focus on their long-term investment strategy and avoid making abrupt decisions based on short-term changes in market sentiment.
Managing Investments During Market Volatility
Investors can take several steps to manage their investments during times of market volatility:
Diversify Your Portfolio
Diversification is crucial when investing in stocks. By spreading your investment across different industries and sectors, you’re reducing your exposure to risk associated with any single asset or sector.
Invest in Quality Stocks
Investing in high-quality stocks with strong fundamentals is always advisable regardless of market conditions. Such stocks tend to weather economic downturns better than lower quality stocks due to their resilience and stability.
Stay Focused on Your Long-term Goals
It’s essential for investors not to lose sight of their long-term goals during times of uncertainty. Instead of making decisions based on short-term fluctuations in the markets, focus on how your portfolio aligns with your long-term objectives.
Consider Professional Advice
Professional advice can be invaluable during times of uncertainty. A qualified financial advisor can help you navigate through challenging market conditions and provide sound advice that aligns with your goals.
Conclusion
In conclusion, drawdowns are a common occurrence in the stock market, and they can be caused by different factors such as geopolitical events or economic crises. Although it’s natural to feel uneasy during times of uncertainty, investors should stay focused on their long-term objectives and avoid making decisions based on short-term fluctuations.
By understanding past drawdowns and using that knowledge to make informed investment decisions, investors can weather the current market volatility without sacrificing their long-term financial goals.
