One element of risk, although not the whole story, is the volatility of an investment. Look at a world share market benchmark such as the MSCI World Index, in US dollar terms. In the 45 years from 1970 to 2014, the index registered annual gains of as high as 41.9% (in 1986) and losses of -40.7% (2008). Over that full period, the index delivered an annualised rate of return of 8.9%. To earn that return, you had to remain fully invested, taking the unsettling down periods with the heartening up markets, but also re-balancing each year to return your desired asset allocation back to where you want it to be.
Timing your exit and entry successfully is a tough ask. Look at 2008, the year of the global financial crisis and the worst single year in our sample. Yet, the MSCI World index in the following year registered one of its best-ever gains.
None of this implies that the market is due for a rebound anytime soon. It might or might not; no-one can be sure. But we do know that whenever there is a great deal of uncertainty, there will be a great deal of volatility. Second-guessing markets means second-guessing news. What has happened is already priced in. What happens next is what we don’t know, so we diversify and spread our risk to match our own appetite and expectations.
Spreading risk means diversifying within equities across different stocks, sectors, industries and countries as well as diversifying across asset classes. For instance, while shares have been performing poorly, bonds have been doing well.
Markets are constantly adjusting to news. A fall in prices means investors are collectively demanding an additional return for the risk of owning equities. But for the individual investor, the price decline only matters if they need the money today.
If your horizon is five, 10, 15 or 20 years, the uncertainty will soon fade and the markets will go onto worrying about something else. Ultimately what drives your return is how you allocate your capital across different assets, how much you invest over time and the power of compounding.