The power of diversification, discipline and long-term focus

17 March 2020 | Investment principles

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These are unnerving times for investors. Markets are roiled by the outbreak of COVID-19 and its potential – and still uncertain - global health and economic impacts.

Investors probably will experience three or four of these type of market events in their lifetime – October 2008 when the global financial crisis hit being the last one; October 1987 being another that is seared into the memories of a generation of investors.

With the benefit of hindsight and the passing of 11 years since the GFC, those market shocks can now be seen in the broader context as fire sale buying opportunities. To channel Warren Buffett would you rather buy when the market is on sale or when it is priced at a premium? The challenge is that when the sharemarket is on sale there it is usually accompanied by a heightened sense of fear or panic.

As investors we crave certainty and confidence in our decisions and we are wired as emotional beings so the challenges are both real and confronting particularly when being bombarded with escalating bad news on the evening news and via social media platforms.

Diversification, discipline and a long-term perspective are an investor's allies when deep in the trenches of a dramatic market downturn. While even a well-diversified portfolio is not shielded from a global equity market drop of 15-20% it will – thanks to the defensive fixed income allocation – soften the blow somewhat. More importantly it has you in position to benefit when the challenging period passes – which it will.

Much can be said about the value of diversification in times like this. When share markets are roaring along at 20% growth rates in a year (remember 2019?) you would probably rather be invested 100% in equities because that captures all that performance rather than the dilution affect that comes with spread of assets in a broadly diversified portfolio.

But if you look at the Vanguard Australian shares index ETF and compare it to the Vanguard Diversified Growth index ETF the data tells the story. The Vanguard Australian shares index ETF has done what it aims to by tracking the market performance closely and for the 12 months ended March 13 the performance is -10.42%.

In contrast the Vanguard Diversified Growth index over the same time period is -5.13%. No investor likes to see their performance number in red ink, but if you had a choice of outcomes the answer seems obvious and it is why Vanguard emphasises the benefits of diversification.

Major market impacts like COVID-19 may not have been predicted but they are not unexpected. A major challenge and impediment for investors in achieving their long-term goals is having the discipline to stay the course. Having a long-term financial plan tailored around your risk tolerance level and financial goals is a truly valuable tool to help you turn down the crescendo of short-term market noise.

 

Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.
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Robin Bowerman, Head of Corporate Affairs at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.

Robin Bowerman

Robin Bowerman