Riding out market volatility: Lump sum versus regular investing
The past few years have been something of a rollercoaster for investors, with financial market volatility reaching its highest level since the 2008 global financial crisis.
The coronavirus pandemic promoted a sharp sell-off in global equity markets in early 2020. But unprecedented stimulus from governments and central banks and optimism over a vaccine for COVID-19 boosted stocks, helping the MSCI World Index end the year 15.9% higher.1
Investors subsequently endured another topsy-turvy year in 2021 but one that ultimately helped cement the recovery from pandemic-driven lockdowns in most major markets, as the MSCI World delivered a 21.8% gain over the year.
However, what looked like a potentially calmer start to 2022 gave way to renewed volatility as Russia invaded Ukraine, oil prices soared, and central banks started tightening monetary policy in the face of record inflation.
Volatility index spikes
We have developed a proprietary turbulence index, which tracks the evolution of parameters based on volatility and correlation - if the measure jumps sharply, it implies that the market is entering a risk-off mood. Our data goes back more than 20 years, to the start of 2000, and allows us to analyze market sentiment over that time.
Unsurprisingly, in March 2020 after coronavirus was declared a global pandemic, investors endured a period of heavy volatility, with the index hitting 88.44, a level not reached since the 2008 financial crisis.
However, throughout 2021, volatility remained relatively benign with our index in single-digit territory for 41 weeks of the year. That was despite ongoing concerns over the path of the pandemic and economic recovery, coupled with inflation at historic highs, and other events that rattled markets in the short-term, such as the US Presidential election and former Donald Trump’s refusal to concede defeat.
More recently, Russia’s invasion of Ukraine at the end of February 2022 prompted our turbulence index to jump to 21.65 from 8.79 the week before – underlining the extent to which volatility can spike almost overnight.
Lump sum or regular investing?
One question many investors have during periods of market volatility is when to invest. But attempting to time the market is a risky strategy as investors who delay putting their capital to work in the hope that prices will fall further, or who sell in the hope that they will be able to buy again at the bottom of the cycle, risk missing out on some of the potentially best gains.
For example - and while past performance should not be viewed as a guide to future returns - if an investor put $1,000 into the MSCI World Index 40 years ago, they would since have seen that lump sum grow to $22,039, equivalent to an annualized total return of 7.8%, as at end December 2021. However, if they missed just five of the best days over that period, their annualized return would have been 6.7%, leaving them with a far lower $14,931.2
In our view, rather than trying to find the best possible entry point, drip-feeding money into the market regularly is a sensible option for many investors.
Of course, you could invest a lump sum. By taking this route, it means your money will be put to work immediately, so you’ll benefit from any price increases. But equally, you’ll also be exposed to any downward movements, so if prices drop soon after you invest, your investment will fall in value too. For example, anyone who invested in global equities at the start of 2020 would have quickly felt the brunt of the market falls during the early months of the pandemic.
However, by investing regularly, you don’t have to face the decision of working out exactly when you should invest and trying to ‘time the market.’ Instead, your money will go into the market every month, regardless of whether prices are falling or rising.
Investing for the long term
Geopolitical issues have flared up with unwelcome frequency over the past few years, from the US/China trade war to Russia’s invasion of Ukraine, demonstrating the extent to which volatility can swiftly return.
Consider too that asset classes tend to be more correlated during periods of market uncertainty, which only serves to add to the instability.
No asset class is going to win out all the time, so diversifying across multiple asset classes and sources of potential investment returns means you should hopefully be suitably prepared for any market wobbles, whenever they arise.
For investors with a long-term approach, regular investments can potentially help them ride out periods of market volatility – and perhaps even mean price fluctuations work in their favor.
The companies are named as an illustration only and do not constitute investment advice or a recommendation from AXA IM.