When asked what the stock market will do, banker and businessman J.P Morgan (1837-1913) replied, "It will fluctuate."
Or so the Wall Street legend goes. While this exchange would have taken place at least a century ago, Morgan's response remains relevant, considering all that's happening in today's global capital markets (including recent events at the bank that bears his name). Of course, market volatility is no more fun today―especially when the direction of the market seems to be downward. However, expatriate investors would do well to remember that 1) market volatility (or fluctuation) is normal, and 2) the important thing is to use market volatility to your benefit. For example, consider a point recently made by Warren Buffett:
"If you are going to be a net buyer of stocks in the future … you are hurt when stocks rise. You benefit when stocks swoon. Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply."
Berkshire Hathaway, Inc. 2011 Annual Report
During a rollercoaster market, this statement may run against what your gut may be telling you. But however contrarian it seems, those investors who have cash to invest in their long-term diversified portfolio can welcome a falling market as an opportunity to invest at a better price. If you think about it, this isn't that much different than the old saying "buy low / sell high." The problem, of course, is that it's usually very difficult to define what is meant by "low" and "high." The media's sometimes hysterical coverage of world events can distort your perspective. Investors―especially those who try to time the market―often have trouble identifying inflection points and therefore miss opportunities to "buy low" or "sell high." Worse, greed and fear often get in the way and investment decisions are made completely backwards. That is, many investors mistakenly "buy high" and "sell low."
For an illustration of this, consider the following study by Morningstar, Inc., a global provider of independent investment research. Morningstar compared the overall long-term (10-year) return generated by an open-end mutual fund from its database to the return of the average investor in that fund, as determined by the fund's net cash flows. The fund itself generated an average return of 7.61% per year for the last 10 years (2002-2011), handily outperforming the S&P 500, which returned about 2.5% per year, including dividends, during that time. Unfortunately, however, the average investor in the fund did not fare so well. In fact, the average investor in the very same fund earned a return of -19.49% per year.
Why the big difference? As Morningstar points out, the simple fact was that the average investor in the fund had extremely poor timing. Specifically, they bought high and then sold low. This was evident in the fund's extremely positive cash flow inflow during the period from July 2007 to June 2008, with peak fund monthly inflows reaching about $6.5B in February 2008 (buy high). Rather than taking advantage of the market's "swoon" from late 2008 as an opportunity to buy low, investors instead fled the fund. The fund experienced continued negative cash outflows from October 2008 through the end of 2011, with the most significant single-month outflow of nearly $3B in October 2008―near the market's bottom (sell low). Although this particular case may be an extreme example, the unfortunate fact is that all too often investors forget the advice of J.P. Morgan and Warren Buffett, and let emotions (greed and fear) dictate their investment decisions.
So what's an expat investor to do to avoid this destructive behavior? First, accept the simple fact that capital markets are volatile―both on the upside and on the downside. Next, develop a long-term portfolio allocation and strategy. Stick to a disciplined plan to invest your savings in the portfolio, and recognize that you can't predict the future or short-term market gyrations. No matter how good, well-argued, or well-supported a market prediction is, something unforeseen is likely to side-swipe it. And if you're investing your savings for the long-term, remember that buying in a weak market (buying low) is to your benefit.