An investment strategy for volatility

Panicky behaviour, both buying and selling, is the enemy of good returns. We've all read it and I've learned it from bitter experience.

RIP the good times. That was the title of a presentation by American venture capital firm, Sequoia, in 2008, preparing clients and investors for what they believed - correctly - was to come.

Two weeks ago Sequoia sent a follow-up note to its founders and CEOs headed: Coronavirus: The Black Swan of 2020. 

Among other things, it contained these words: “Having weathered every business downturn for nearly fifty years, we’ve learned an important lesson — nobody ever regrets making fast and decisive adjustments to changing circumstances. In downturns, revenue and cash levels always fall faster than expenses.”

So here’s the dilemma for investors: do we make a fast and decisive adjustment to changing circumstances, or do we leave the adjusting to CEOs and hold firm and refuse to panic?

Panicky behaviour, both buying and selling, is the enemy of good returns. We’ve all read it and I’ve learned it from bitter experience.

And as I’ve been saying at the seminars we’ve been doing around the country lately, in order to get the long-term compound return of 8-9% from the stockmarket you have to be in the market through good times and bad. 

Obviously it’s more important to be in the market for the good times, but while it’s true that picking tops and bottoms would enhance those returns, it’s impossible to do that consistently. 

I met a bloke in Perth the other week who said he got out of the market in January because he could see what was happening, and is feeling bloody great now (he said). Good for him, but the trick now is to get back in: missing the rally is almost as bad as not missing the correction.

The ASX 200 has adjusted downwards by 26% since its record all time high on February 20. Is that enough? Should we buy the dip? It’s impossible to know – we’re in the thick of it, and the medical crisis seems to have a long way to run, especially in Europe, the United States and Australia, even as it seems to be coming under control in China.

The key to long-term investing success through good times and bad is portfolio rebalancing and/or dollar cost averaging, not dramatic moves in and out. These are disciplined, systematic ways to ensure you sell high and buy low, rather than the other way around.

Portfolio rebalancing involves holding to an asset allocation strategy and when one asset class gets out of whack – say, shares going very high relative to fixed income – you sell some to return the proportions back to what they should be.

Dollar cost averaging is a long-term saving strategy that involves investing the same amount of dollars each period, so you buy less of them when prices are high and more when prices are low.

These strategies are the way investors can match what CEOs are doing with their companies, in line with Sequoia’s advice. Selling everything would be like a CEO sacking everyone, thinking he can hire them back later.

Which, by the way, is how Donald Trump defended his huge budget cuts to the Centre for Disease Control, which has turned out to have been not a very good idea. 

"I'm a businessperson. I don't like having thousands of people around when you don't need them," Trump said. "When we need them, we can get them back very quickly."

Except you can’t - it doesn’t work like that in the real world.


All InvestSMART capped fee diversified portfolios have a regular contribution plan making dollar cost averaging easy. Click here to find out more.

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