Baked in the Cake

Taking Stock of Geopolitical Events and Market Disruptions

Baked in the Cake

Turbulent times can lead to apprehension and a certain sense of malaise by investors. This includes everything from epidemics and natural disasters to military conflicts. Indeed, Russia's invasion of Ukraine is an important reminder that geopolitical risk is a part of investing in global markets. 

Behavioral finance scientists have related making investment decisions during such periods of heightened volatility to driving while feeling the symptoms of vertigo. Trying to predict how markets will react in the moment based on the latest geopolitical scare too often spurs investors to shoot from the hip, so to speak. 

At the same time, it's probably worth noting that a typical IFA Index 100 Portfolio heading into February had an allocation to Russian stocks of 0.12%, according to Morningstar data. Along those lines, Dimensional Fund Advisors at the beginning of this year listed Russian equities as representing anywhere from 0.3% to 1.8% of its funds with emerging markets exposure.

Mixing bonds into an IFA Index Portfolio — whether it's a relatively small amount (like Portfolio 90 with 10% in bonds) or larger percentage (such as Portfolio 50 with half in fixed-income) — translates into even less exposure to Russia's stock market. In fact, DFA funds used in IFA's globally diversified portfolios typically don't include any Russian-denominated bonds or emerging markets issues. That's due to long-held concerns about credit risks tied to Russian-issued debt — along with bond ratings for emerging markets on the whole.

Regardless of the geopolitical event, emotional reactions based on relatively short-term bouts of volatility can pose a real and present danger — i.e., getting sucked up in the latest market head fake and missing out on any subsequent rebound. The table below shows how major events in the past could've whipsawed a normally patient investor's portfolio. In a majority of those cases — from Japan's bombing of Pearl Harbor and North Korea invading South Korea to terrorist attacks on 9/11 — the Dow Jones Industrial Average took a precipitous fall. 

Consider, however, that most of the time such disruptions didn't lead to negative results 12 months later. 

The chart below illustrates how different parts of the market — as depicted using different IFA indexes — performed after each event listed in the table. 

This piece of evidence raises another significant lesson from history that our wealth advisors like to pass along to investors. Namely, it shows that while stocks on the whole have kept rising after such major geopolitical and military events, different types of equities (e.g., asset classes) can increase in value by various rates. 

For example, after World War II began in 1939 (marked by the blue #2 dot), domestic small-cap growth stocks rebounded roughly in similar fashion to the IFA Small Cap Value Index for the next several years. Then, look at how those asset classes did over an extended period. By the end of 2021, the small value benchmark was significantly outperforming its sister index. In fact, small-growth stocks as measured through such a lens were definite laggards.   

Research into behavioral finance suggests that many investors tend to project losses forward after prices have declined. And if market turbulence intensifies, investor angst tends to increase, especially when price fluctuations extend past one or two trading days.  

A prime example: During the global financial crisis in 2009, it wasn't uncommon to see domestic large-cap focused indexes record a drop of more than 20% within a month. Such short-term setbacks, though, turned out to be a false indicator for investors — at year's end, the IFA U.S. Large Company Index wound up gaining 26.62%. (The IFA U.S. Large Value Index did even better by producing a return of 30.19% for the year.)

The takeaway here is clear: Volatility shouldn't be considered as an anomaly. Whether caused by a military action or pandemic, a roller coaster effect in market pricing is a regular part of investing. 

Still, during bouts of extreme market volatility IFA's wealth advisors realize it's only natural to become uneasy about your long-term financial security. While such emotions can't be totally ignored, focusing on facts and education can go a long way towards developing a lasting and rational investment strategy. 

Sorting through all of the historical data is one challenge. Putting such information into a practical perspective to help construct a holistic portfolio strategy is another. As a result, we invite all IFA clients to discuss creating an individually tailored financial plan with their wealth advisors. We offer such a holistic planning tool on a complimentary basis. If you've already started such a process, we also encourage you to check back with your advisor when major life events happen or notable changes in your financial goals take place. 

In the meantime, in case you're feeling tempted to make portfolio tweaks, we like to recommend you take our Risk Capacity Survey. This online tool is often used by IFA clients to reassess whether they own the most risk-appropriate portfolio given each investor's unique financial situation.


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.