The coronavirus proves the importance of diversification again - February 27, 2020

The coronavirus proves the importance of diversification again

We often mention the importance of diversification when investing, and the new coronavirus outbreak just proves our point again. An event like this could not have been predicted but it affects the markets. Discipline and cool headedness might help investors through the issue.

After China, the European coronavirus outbreak in Italy, and the disease’s appearance in several new countries sent shockwaves through the stock markets around the world. After record breaking performance and serious heights, S&P 500 fell, but European and Asian markets also took hits.

Not the first time a virus affects the world

The coronavirus is far from being the first disease that impacts the global market in modern history. At the beginning of the 2000s, the SARS virus (which is related to the corona disease) also sent waves through the world. There were other notable viruses that had a negative impact, as it can be seen from the chart below.

Another notable example was the Ebola outbreak of 2014, which had a very similar effect on the economy to the coronavirus so far.

It's important to see, though, that markets recovered after these hits, and they went higher than before with time.

Diversification was and is key to success

This doesn’t mean that this outbreak isn’t an issue to consider. An unpredictable situation like this is the reason why we write so often about the importance of diversification in a successful investment.

How could diversification help when stock prices fall? Simple: while shares took a hit, gold gained momentum again. We also often say that the precious metal is a safe haven in situations like this (see: Diversified investments? Gold should have a role in them!), and coronavirus proved that once again. What’s more, gold was already at a great place, and now it went even higher (see: Gold went to a 7-year high in January).

But diversification isn’t only about gold. Generally speaking, a well thought out investment portfolio is more than only stocks. This means that next to shares, government bonds and ETFs also have an important part of every portfolio. These can balance out the negative effects on the stock market and can help a lot to avoid losses. (See: Stocks and bonds: how to mix them?)

A time to test discipline

Another thing we call an investor’s virtue is discipline. Our blogpost “The price of choosing emotions over discipline” proved perfectly how much emotional thinking can cost an investor in situations like this. JP Morgan also calculated that between 1995 and 2014 an investor could have lost $30 thousand by reacting negatively to every market fluctuation.

This doesn’t mean that there’s no volatility on the markets due to coronavirus. It can also affect global production, especially if it takes longer to eradicate the virus, but cool-headed investing doesn’t mean that we shouldn’t care about possible negative effects. It much rather means that we’re keeping a level head. Therefore, jumping out of the market when prices face a swing can hurt investors. Especially (as we’ve seen from the charts above) since prices go back, and even higher on the long-term. In situations like this, investors often wait for prices to reach a low-point and think about rebuying, to earn even more on the long run.

Altogether, even in a serious situation like this, we still believe that the best thing to have is diversified portfolios and being disciplined.

Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.