Investment in volatile times
Market volatility has been at near-record levels in recent months, as investors respond to the uncertainty in Europe, the expectation of a US interest rate rise and the problems facing China.
Market volatility has been at near-record levels in recent months, as investors respond to the uncertainty in Europe, the expectation of a US interest rate rise and the problems facing China. How should we deal with it? Just go on holiday and ignore the noise or take evasive action?
What is volatility?
Volatility is simply the up-and-down movements of the market. Most investors naturally find periods of high volatility rather scary. Constant news reports about, for example, the European debt crisis creates more uncertainty which can then impact the market further. Some institutional investors can take advantage of these exaggerated market movements, but most of us are certainly not in a position to do that.
Is volatility bad?
Daily market moves can sometimes be dramatic, but there is often a strong relationship between volatility and long term market performance. Wren, the Wells Fargo strategist, said investors must remember that "volatility is your friend, not your enemy”. That is especially true if you believe the economy will continue to improve and inflation will remain modest. You can then look at market falls as an opportunity to put cash to work.
Should you take action?
Warren Buffett, the highly successful American investor and philanthropist said “The Stock Market is designed to transfer money from the active to the patient.” In other words, it is usually best to keep calm during periods of high market fluctuations and benefit from long term growth.
The foundation to any successful investment portfolio is firstly to establish the risk that you are willing to take with the money that you will be investing. Every asset can be risky in isolation and the best way of controlling risk is to diversify.
You should certainly make sure that your portfolio is regularly rebalanced. Rebalancing simply means that the portfolio is put back to the original percentages invested in each asset class. This rebalancing procedure has the benefit of capturing the gains made by the ‘winners’ over each period and investing those gains back into the ‘losers’. This obeys one of the key requirements of a good investment process, that of buying low and selling high and this is instrumental in ensuring that you meet your long term financial objectives.
Ways to deal with volatility
There are two ways to profit from volatility. Market timing and pricing. By timing we mean anticipating the action of the stock market - to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward. By pricing we mean to buy funds when markets are particularly cheap and sell them when markets look expensive.
As financial planners we meet with many fund managers during the course of the year and few of these will make big bets on the future direction of any market, which they refer to as big macro swings, because it is very difficult to always get it right. On the other hand it is easier to get a feel for when valuations look cheap or expensive.
A major investment house that time in the market, not timing the market is the best way to proceed. So by all means go on holiday, and leave your diversified, regularly rebalanced, portfolio to take care of itself.
Past performance is not a reliable indicator of future performance. The value of your investment and the income from it can go down as well as up and you may not get back the full amount you invested.
The information in this article does not constitute advice and should be used for informational purposes only. This content has been provided to Helm Godfrey by Taxbriefs.