Set aside After experiencing a loss it is always tempting to change to a more conservative investment strategy, but don’t be too quick to dispense with your current investment approach. Let’s imagine that back in 1901 you set up two portfolios, one a fixed, balanced mix of 60% global equities and 40% global bonds, the other a portfolio that starts with the same balance but immediately takes a defensive position by moving entirely into 90-day Treasury bills (in other words, cash) after a negative calendar year, only moving back after a year of positive returns.

This scenario assumes that an investor needs about a year of positive returns to regain their confidence, and assumes a three-month-long information and decision-making lag. The results are interesting. The ‘switching’ strategy does better between 1929 and 1931, when there were three consecutive years of negative calendar-year returns from the balanced mix. It also comes into its own in the mid-1970s, with 1973 and 1974 both producing negative returns for the balanced portfolio.

However, the ‘switching’ portfolio produces an average long-run return of 6.9% a year, versus 7.8% for the balanced fund. That means that $100 placed in the switching portfolio in 1901 would have grown to $90,404 by December 2002, whereas the constantly balanced portfolio would, by then, have grown to $264,435. The obvious conclusion is that switching to cash after a bad year is not always the answer.

The best approach is to adopt an appropriately diversified long-term investment strategy and stick to it. The key is not to be thrown around by the sort of unexpected events or calamities that result in short-term volatility.

ARTICLE REPRODUCED WITH THE KIND PERMISSION OF SMART INVESTOR.