Don’t panic over market volatility

“The key to successful investing is not predicting the future but looking at the present with clarity” -J.P. Morgan Funds CFA Chief Global Strategist Dr. David Kelly

Volatility in the stock market is usually characterized by upward and downward movements in prices of securities. Higher volatility means that the prices of securities fluctuate significantly in either direction in a short period of time and is typically measured by the standard deviation of the return of an investment. This is a quantitative measure that essentially indicates how widely returns deviate from an overall average return.

The volatility that is experienced in the market invariably adjusts over time and if investors hold their shares for more than a few years, the market becomes less volatile than when investors trade on a short-term basis.

When markets move up and down in the short-term, the investors tend to start questioning their investment strategies. Some investors are tempted to even pull out of the market. This is especially true of new investors. But volatility should not be the deciding factor as to whether or not investors should immediately exit. It is crucial for investors to be aware that volatility is inevitable and with a proper understanding of volatility and its causes, investors should be able to deal with it better and take advantage of investment opportunities resulting from such markets. Let us look at some strategies that can be used during times of volatility.

Purchase shares at lower prices

When there is downward market volatility, the investors who invest in the stock market for the long term can purchase additional shares in anticipation that the market will perform well in the future. This approach will give investors a chance to increase their returns over time by making more investments.

Since markets are mostly driven by corporate fundamentals, one must bear in mind that long-term investment too requires homework. For a company that depicts a strong balance sheet and steady earnings, short-term volatility will not affect the longterm value of the company. In fact, this should be a good time to buy the shares of such a company.

Creating right investment plan

The investors must ensure that they have an investing plan that serves them well during all types of markets. By having in place a strategy, which takes into account their goals, objectives, tolerance for risk and time horizon, the investors will be able to steer through periods of uncertainty when many people are panicking or acting out of fear.

Furthermore, an investment advisor can assist investors to construct an investment portfolio that is more in line with their personal risk tolerance, making it easier for them to withstand typical market fluctuations. It is also important to set realistic expectations because unrealistic expectations can leave their finances in a mess. The key to success in the longterm is to have realistic expectations and patience to allow investments to grow in a disciplined manner.

Do not try to time the market

It is impossible to consistently predict the market accurately i.e. what the market will do in a day, week or year from now. Remember the old stock market adage: “Time in the market matters more than timing the market.”

This is the reason why many financial professionals recommend that the investors choose sound investments that match their goals and risk tolerance and hold them for the long term. With such an approach, there is no reason to panic when the stock market drops.

Besides, growing the wealth is a longterm process and how an investor reacts to market swings is what makes the difference. Likewise, the investors who cannot endure short-term volatility should consider moving to safe assets.

Invest regularly, despite volatility

If an investor invests regularly over months, years and decades, short-term downturns in the market will not have much of an impact on the ultimate performance. Instead of trying to ascertain when to buy and sell shares in the market based on its conditions, if investors take a disciplined approach of making investments regularly, i.e. weekly, monthly, etc. investors will be able to steer clear of the pitfalls of market timing.

Staying clear of investing because of market volatility can endanger your longterm goals. A good strategy is an automatic investment plan. Consider investing a set amount of money regularly and these investments can really add up. A method of periodic investing is dollar cost averaging, a way to invest over the long term by guiding the investor to buy more shares when the prices are low and fewer when the prices are high.

Stay diversified

Diversification is a method that is used to reduce risk by allocating investments among various financial instruments and industries. Although diversification does not guarantee against loss, it is the most important component of reaching long-range financial goals while minimizing risk. It strives to maximize return since different asset classes will not react in the same way in adverse events. The benefits of diversification tend to happen in long-term portfolios.

Rebalancing

It should be noted that deploying an asset allocation and rebalancing strategy can help investors combat volatility and help them make challenging investment decisions in any type of markets. When following an asset allocation investment strategy, the investors can apportion a percentage of their investment portfolio to certain asset classes, balancing their risk and reward based on factors such as time horizon or risk tolerance.

Rebalancing means periodically buying or selling assets in a portfolio to maintain an original level of asset allocation. If an investor’s original target asset allocation was 50 percent stocks and 50 percent bonds and if the stocks performed well during a given time period, resulting in the stock weightage increasing to 70 percent, then the investor may decide to sell some stocks and buy bonds to get the portfolio back to the original target allocation of 50/50.

A systematic rebalancing approach to bring the percentage invested back into alignment allows the investors to avoid the game of trying to time the market. Furthermore, the best way to maintain an ideal asset allocation is to rebalance regularly, even when markets are volatile.

Making sound financial decisions is not an easy task. The investors are regularly faced with market fluctuation that can impact even the best investor. Volatility has led many investors to make emotional and irrational decision that has cost them in the long term. By understanding market volatility better investors will be in a better position to make thoughtful and deliberate decisions to benefit from such market conditions.