Don’t fear volatility – use it to tweak your portfolio

Volatility is a given in the investment world, and in the past year investors have been exposed to several events that sparked short-term volatility. There were irregularities around corporate finances, sovereign events like the ANC elective conference, and concerns around rising inflation in the United States, which led to a sharp decline in US markets.

When the headlines look bleak, many investors become excessively pessimistic and reactionary.

This can be more detrimental to longterm wealth creation than the volatility that sparked it in the first place. Here are the four best investment lessons we learn from it:

1. Volatility brings risks – but also rewards

In equity markets, volatility is inevitable. Consider it the “nature of the beast”. Unfortunately, many people panic at the first sign of market corrections.

This is usually when wealth managers receive frantic calls from their clients, because the value of their investments has suddenly decreased.

What many investors lose sight of in times of uncertainty and sharp corrections is that this volatility provides investors with opportunities to access markets at lower prices.

2. Despite this short-term volatility, equities have the highest potential to create wealth

Equities have proved time and again that as an asset class they deliver the highest returns over the long term.

It is a risky asset class, however, with the potential for large losses in capital over the short term, so the duration of your investment is crucial.

The inherent risks are reduced and eventually negated if your investment horizon is longer than five years.

If you cannot commit to five years – and preferably longer – equities are probably not the right investment for you.

3. The biggest threat to your wealthcreation efforts is … you!

The inherent fear of losing money drives many investors to make poor decisions. Research shows that we feel the pain of losses far more acutely than we enjoy gains.

This is referred to as loss aversion, and it’s the reason why investors are more likely to make irrational decisions based on losses than they are to be reckless with gains.

Emotions related to losses weigh so heavily on some investors that they would rather sell off their equity investments, so locking in the losses permanently, than stay invested and risk further losses in an uncertain period.

4. Use volatility as an opportunity to ensure that your portfolio is still correctly positioned

A hands-off approach to your investments can be healthy in volatile times, but don’t be so passive that you miss out on necessary tweaks and updates.

Corrections often prompt market participants to perform sanity checks, which is very healthy. Sometimes periods of volatility will bring to light shortcomings in your overall investment strategy or portfolio construction.

This can be a necessary prompt to reconsider whether your current position is still best suited to your needs.

A plan that was put in place 10 years ago may need to be adjusted and re-balanced.

This is also a good time to check that your portfolio is appropriately diversified, given that diversification is one of the best ways to mitigate the risks inherent in equity investments.