As we are in the midst of turbulent times, we have decided to focus on volatility and what this means in financial markets.
Market commentators seek to make headlines by making bold predictions about the year ahead. However, the truth is that no-one has a reliable crystal ball and it pays to be sceptical of stories that attempt to neatly fit recent market movements into a forecast.
In this edition, we outline what volatility means and how it is different to risk. We also share some practical tips on coping with volatility.
Does volatility mean that the investor’s portfolio is experiencing more risk?
Volatility is a statistical measure, and it is a measure of short-term turbulence or transient aberations in the market. Whilst volatility can be unsettling, it’s not the main measure of risk. The main measure of risk is permanent loss of capital. Risk of a permanent loss is a function of valuation, fundamentals and behaviour. It is money going somewhere where you are never going to get it back.
But really if you are a long-term investor, saving for the long-term or your retirement, then you need to embrace volatility because that’s when the real opportunities come along. Volatility allows you to buy things cheaply and that’s an opportunity when it comes to investing.
What practical tips are there when dealing with volatility?
- Make sure that your portfolio is at the right level of risk for you.
- Don’t try and time the market. Very few people, if anyone, can do it. If you are buying over a long period of time regularly, and it is part of your strategy and routine, then that’s the best way of investing.
- Periods of market turbulence can be especially dangerous for investors as they tend to elicit an emotional response and heighten the behavioral biases to which we are all prone. Left unchecked, these biases can lead to us making poor decisions which can harm long-term investment returns.
- Maintain a long-term perspective to enable you to look through volatility. You need to be able to cope with day-to-day volatility to stay invested for the long term.
- Remember that investment is a long-term pursuit and put all recent price movements in this context. While a sudden market fall may induce panic, it means little in the context of a 10 or 15-year investment horizon.
- Try to avoid the sensational headlines that can lure you into action. It’s normally better to read books than listen to forecasts.
- If you are going to look for opportunities, ensure that you have a robust framework for setting the real value of assets. This will provide an anchor for your expectations and help you avoid overreacting to short-term price movements.
- Remember that investors tend to make too many decisions rather than too few. So, if in doubt, seek a second opinion from an independent qualified financial adviser, such as myself.