Market Pullbacks...Threat Or Opportunity?

Rob Hubbard CFP, Investment Advisor
The Police Credit Union/Aviso Wealth

As investors, we want to follow the simple principle of buying stocks low and selling higher. The reality is the path is not a direct line up (and to the right) so we need to be prepared for some setbacks along the way. The key is to know when to seek shelter and when to stay the course.

Are my emotions giving me the right signals as an investor?  

It should not be a surprise that investors are overly confident in the good times and very uncomfortable in the bad. While it is human nature to feel these emotions, they are inverse to the actions that are needed to actually achieve higher returns over time. Think of overconfidence (peaks) as times when stocks are being bought at a premium and lack of confidence (troughs) as times when stocks are being purchased on sale.  

The more you are able to read the confidence levels in the market, the more you are able to avoid overpaying for companies and the more you will see that market weakness creates opportunities.

Do I own quality investments or do I need to get defensive?

There is a different strategy for when to hold low versus high risk companies. Low risk companies are the larger, more established companies, providing consistent profitability and usually pay dividends to their investors. High risk companies are those who may not have achieved profitability yet but are experiencing above average growth and have great potential as they grow their businesses. When markets become uncertain, there is a change in confidence and investors tend to switch from high risk to low risk investments. This transition is due to Investors wanting to know their investments will be in companies that can withstand weak moments in the markets. When confidence returns, a “risk on” mentality returns and investors are more willing to invest in higher risk companies which can provide above average returns moving forward.  

If you hold growth oriented companies, your journey will be more exciting and you will need to be more active in your decision making when market weakness arrives. Holding quality companies with strong management teams, ensures a more comfortable experience through good and bad times.

Why are downturns in the markets good for your portfolio?

For the most part, the only time an investor should want the market to be incredibly overconfident is when they want to sell their investments. During market weakness, you get a lot of help in achieving your longer term goals. You are able to buy more shares at lower prices than you would if markets were strong and more expensive.. Dividends you receive can be reinvested at the lower costs available in downturns which means you get even more shares to participate in upturns when they return. Finally, in really bad markets, you can get companies at bargain prices as other investors stay on the sidelines and valuations become attractive.

Recognizing that downturns in the market are creating opportunities for your investments helps to maintain the discipline it takes to create wealth over time. 

Revisit who are you as an investor?

It should not be a surprise that investors tend to be more sensitive to market declines than increases. While portfolios are created with a mix of offense (stocks) and defense (bonds), investors tend to be more willing to be aggressive at the start as they over appreciate the growth potential of perfect markets and underappreciate the eventual downturns that will ultimately occur. This is a normal approach and while we don’t want to revisit this often, market downturns create the perfect test on if the mix was properly created. Being uncomfortable is not enough to change gears but wanting to sell the portfolio suggests your gas pedal was bigger than it should have been.

Use market weakness as an opportunity to tweak your mix of stocks and bonds to ensure you create a portfolio you can live with for years to come.

Market pullbacks are great tools for becoming a better investor and in getting better returns over time. By understanding what you own in your portfolio, knowing when things are cheap or expensive, and if our portfolio truly reflects you as an investor… you can have great perspective in good times and bad. While I am not telling you to enjoy the uncomfortable times in the market, I am advising you to step back in these moments and understand how it can help with your long term investing.

The markets always have opportunities and threats to deal with and this year has more than most. If you are looking for a review of your existing portfolio or simply need a rational view of how to invest in our current environment, reach out to one of our wealth advisors.