Investors often describe markets or stocks as 'volatile' - most recently, it seems to have been used to cover much of the period since the outbreak of the pandemic in a negative context. But, as we demonstrate in a selection of articles below, that is not necessarily the case.
Volatility is just a statistical measure of how much prices swing around their average value. Investors should perhaps learn to live with volatility, accept it as part of the day to day reality of investing. To help them, we have put together a series of articles showing how some of the drawbacks traditionally associated with this concept can be minimised, plus a handy five point checklist for all investors.
Time is the friend of the wonderful company, the enemy of the mediocre. Warren Buffett
What is it?
Volatility is a relatively simple but important concept in finance. Usually associated with markets or stocks, it measures how far an asset’s returns differ from its expected or historic value. Large and rapid moves in a market index or share price, either up or down, are often described as ‘volatile'
What causes it?
Financial markets are constantly anticipating or reacting to a wide range of drivers. These include economic conditions, geopolitical events or corporate newsflow, all of which will influence investor sentiment. China at the beginning of the Covid pandemic in 2020 pushed the benchmark VIX Index, a measure of expected volatility also known as the ‘Fear index’ to a record high of over 80, compared with its all-time single-digit low in 2017.
Volatility can be your friend
Yes, volatility is an ever-present risk for investors, but it is also an opportunity. “Expect volatility and profit from it” was a key investment principle of Benjamin Graham, the long-time mentor of Warren Buffett. He believed that highly volatile financial markets provided opportunities for investors to buy when prices were lower and vice versa, compared with periods of low volatility.
Investors will inevitably face market volatility when investing. While they can prepare for some of the adverse effects of high volatility (i.e. weaker markets) by diversifying their wealth between different asset classes and sectors, it can also provide opportunities to enhance investment returns depending on how their portfolio is constructed.
Managing market driven emotions
Volatility in global markets is normal. Despite this, and many investors' tendency towards 'loss aversion', we explain why it is important to keep to your long term goals and avoid making decisions based on short term fluctuations.
Stocks don't go up every year but over the long term, they have risen roughly every three years out of four in the US. We examine how higher corporate productivity and cashflow, population growth and adjustments to what investors are prepared to pay supports long term investing.
This is a simple and effective technique to deal with the difficulty of buying and/or selling at the right time. It encourages a disciplined approach to investing and we show how it helps to smooth the effects of adverse market conditions.
By selling a holding for less than they bought it for, investors will be locking in their losses. We examine what this means in market environments which have continued to prove resilient despite the dramatic and volatile narrative of recent years.
Market sell-offs are perhaps more frequent than you think. Despite this, the long term evidence shows that markets consistently recover. It may be daunting to consider buying after corrections, but investors should remember that these can offer opportunities for excess returns.
Although the market can move up and down over the course of a year, or several years, it has historically trended upwards over longer periods of time. If your investment horizon is longer than just a few years, remember that it’s likely the market will recover losses over that period of time, although this is not guaranteed.
If you know that you’re likely to react to market declines, you may want to keep your portfolio in more conservative investments. It’s much better to be a bit more conservative and hold on to your investments during market downturns than to buy riskier assets and sell if the market crashes!
Select the right mix
From year to year, it’s difficult to predict which asset classes will be the best performers. Diversifying your portfolio using a range of different investments could help to ensure that they don’t all behave in exactly the same way. So while one part of your investment portfolio could be falling in value, the others may be flat or rising to balance it out. This differentiation in potential returns aims to reduce portfolio volatility, smooth out peaks and valleys in returns and help avoid unnecessary risk.
Avoid locking in losses
Selling as the market nears its bottom is a form of ‘behavioural bias’ that can have a negative effect on your financial health. All too often, losses are locked in and opportunities for future gains are lost because investors often put money into the stock market as it rises and pull money out as it falls.
Consider the bigger picture
Experts recommend remaining calm and looking at the bigger picture. Remember that most market downturns are normal. As an investor, it is risky to make decisions based on emotions, especially fear. History shows that the best strategy is to remain calm and maintain your long-term perspective. And if you’re ever in doubt speaking to a financial adviser before making a decision is a good first step.
Guide to investing in volatile markets
From the importance of diversifying your portfolio to a five-point investment checklist, this guide highlights what to consider when investing in periods of market volatility.
Access a range of articles, podcasts, videos and useful materials from our expert team at AXA IM Select and our leading, global fund group partners. You will find information on a variety of topics such as financial markets, multi-manager investing, macroeconomics, responsible investing and ESG and themes such as megatrends to help keep you up to speed on the latest news and views.
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