In the February edition of The Informed Investor we cover the increase in market volatility that started off 2022 and a couple of investment principles that can help you stay invested in difficult markets.
When it comes to managing our finances, the toughest battles are usually with ourselves. Those battles happen along various lines, from balancing spending now and investing for the future to sticking to an investment plan that’s right for our goals.
It often feels more difficult to stick to your investment plan when financial markets are volatile, as they were throughout January 2022.
Policymakers provided large amounts of stimulus to support individuals and businesses during the pandemic. And nearly two years later, the economic recovery has been impressive: unemployment is low, while demand for goods and services has rebounded.1
A less positive development is that inflation has continued to heat up, challenging original forecasts that it would be temporary. RBC Economics reported that the Canadian Consumer Price Inflation (CPI) index gained 4.8% over the year ending in December 2021 — the highest yearly increase in the last 30 years2. With similarly high inflation numbers in the US and the UK, there is some unease about how long inflation will last.
One factor contributing to the recent volatility in financial markets is uncertainty regarding how aggressively central banks will be in their effort to slow inflation through raising interest rates and removing other accommodative policies2.
Where we are now
According to RBC Global Asset Management’s recent market update, highly valued growth and technology stocks tend to react negatively when interest rates rise, while value oriented sectors such as energy and financial tend to fair better1. At the time of writing, the tech-heavy Nasdaq Composite Index was down 14.7%3 for the first month of 2022. Yet over the same time frame, the more financial and energy-focused S&P/TSX Composite Index (which contains around 250 of Canada’s largest publicly-traded companies) was down only 3.2%3.
How diversification can smooth the investing experience
The investments in different industry sectors, asset classes (like stocks versus bonds), and regions perform differently over time. And no one can reliably predict which kind of asset will be leading the market in any given year. When your investment portfolio is well-diversified, your money is spread across a mix of these investments. This allows the higher and lower performing parts of your portfolio to offset each other.
Diversification improves the characteristics of your portfolio by lowering its risk level (or the ups and downs you are expected to experience) for a given level of return. But it’s the behavioural benefits of diversification that are even more important. A portfolio designed to soften short-term market declines makes it easier to stick to your investment plan in difficult market periods.
Rebalancing Portfolios with RBC InvestEase
A diversified portfolio is desirable during periods of volatility, but rebalancing your portfolio is also a helpful strategy. During periods of heightened volatility, your asset allocation (or mix of stocks, bonds and cash) can drift from its original target. Rebalancing is the process of realigning your investments back to this original target. At RBC InvestEase, we have disciplined process to get your portfolio back on track when the ups and downs of the market cause your investment mix to drift from your target.
When our advisors rebalance your portfolio, they are selling some of the investments that have drifted higher than the original target, and using those proceeds to buy the investments that have drifted lower.
Like diversification, rebalancing also helps smooth your investing experience by keeping your investment risk level aligned to your goals. This process is difficult for many investors to do themselves as it requires discipline to sell what has increased in value and buy what has declined. But with RBC InvestEase you don’t have to make these decisions yourself because our advisors take care of rebalancing your portfolio on your behalf.
If you want to dig into more detail on current market developments, check out the latest memo from RBC Global Asset Management’s chief economist Eric Lascelles.2
Have more questions about the recent market volatility? You can reach out to the RBC InvestEase Portfolio Advisor team at email@example.com.