If you own funds or ETFs and you're watching the market slide, you understandably might be concerned. In fact, some of you might even be worried enough to consider making a change to your fund investments or overall allocation. But that's probably a bad idea.
Before I explain why, here's a bit of perspective: My Morningstar colleagues and I conduct research on thousands of funds and ETFs globally. We assign a rating to every fund we analyze, with that rating signaling our level of conviction in the fund's future prospects. While the rating isn't advice, it offers a sense of how strongly we believe a fund is likely to outperform or underperform in the future.
Given this, you might wonder whether we're considering changing any of those ratings to, say, send a signal about the impact of today's market tumult on these funds. The short answer is, we're not changing a single rating for that reason.
Why not, and what relevance might that hold to any of you who are feeling queasy and considering making changes? When we're evaluating funds, we're doing so over a multiyear timeframe. Not only does this improve our odds of succeeding, but it also allows us to see volatility for what it is (i.e., a fixture of markets) and isn't (i.e., an omnipresent threat to one's success). And, on the flipside, it blunts the risk that we'll react impulsively to short-term events.
Thus, if you're thinking about making a change to your fund investments, it's well worth asking yourself--as we try to do when rating funds--whether you're overly fixating on the short-term at the potential risk of your long-term success.
That's not a trivial risk. Indeed, our research has found that investors harm themselves by inopportunely trading in and out of funds, often in chasing performance or, as in this case, fleeing perceived danger. So how do you talk yourself down from that ledge?
Here are a few questions worth asking yourself:
- Why were you in this fund to begin with? When you woke up yesterday or a week ago, what parts of your investment thesis still held together, and of those, which aren't intact anymore? If the fund was chosen as part of a broader plan, does that plan still hold?
- If your plan has changed, does that change correspond to a broader change in your goals or circumstances? How did your goals and circumstances change in the last week or so?
- Is the fund you're selling part of your broader portfolio allocation and, if so, how does switching it affect the overall pie? What traits will you seek in a replacement?
- If you're thinking about replacing the fund with something that's less risky, what are you giving up?
- If you didn't see this bout of market volatility coming, what gives you confidence that you'll know when it's time to undo any changes you're making now?
To be sure, events like these can sometimes serve as a needed "wake-up" call to investors who haven't clearly defined their plan or have been blasé in making overly aggressive fund selections. In circumstances like those, it of course can make sense to revisit fund choices and the overall portfolio allocation. But for other investors, such as pension plan participants who routinely contribute assets to a balanced strategy, episodes like these can offer validation of sorts--after all, this is why you diversify in the first place.
As investors, we're only humans. But by placing volatility into a broader context and asking ourselves certain questions before transacting in haste, we can avoid costly errors and improve our odds of success. That same mindset informs our approach to analyzing funds, which is why you won't see us making radical changes to our ratings in light of the presidential election outcome.
