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The perils of trying to time volatile markets

Key takeaways

  • Missing a handful of the best days in the market over long time periods can drastically reduce the average annual return an investor could gain just by holding on to their equity investments during sell-offs.
  • While missing the worst days can potentially offer higher returns than a “buy and hold” strategy, disentangling the best and worst days can be difficult, since historically they have often occurred in a very tight time frame — sometimes even on consecutive trading days.

What it may mean for investors

  • There appears to be some benefit to missing both the best and the worst days, so an investor may wish to use tactical asset allocation adjustments in an effort to reduce equity exposure when the risk of a recession or bear market rises.

Strategies to manage volatile markets

We believe that staying fully invested in equity markets over a full market cycle is more beneficial than selling into volatile markets and attempting to avoid the worst-performing days. Historically, there appears to be some benefit to missing both the best and the worst days, so an investor may wish to use tactical asset allocation to reduce equity exposure when the risk of a recession and bear market rises and increase equity exposure as the economy and markets recover.

We also suggest rebalancing — buying asset classes that have fallen below a portfolio’s long-term allocations and selling those that are higher than long-term allocations — during periods of market volatility. We believe regular rebalancing can help to ensure that a portfolio’s allocation stays diversified and aligned with desired goals.

Diversification has the potential to provide more consistent returns and less downside risk through lowered volatility. Attempting to smooth the ride for investors is important because it can reduce the temptation to abandon a diversified portfolio when one asset class is outperforming or underperforming during a given time period. Attempting to reduce downside volatility can be critical to long-term performance because it can allow a portfolio to recover more quickly in the event of a catastrophic loss.